Purchase term plan from insurer which has a high claim settlement ratio

Life insurance products fall into three broad categories—endowment plans, unit-linked insurance plans (ULIPs) and term plans. While endowment plans and ULIPs are hybrid products that combine both insurance and investment, a term plan is a pure insurance product. It is much cheaper than ULIPs and endowment plans. Since it is advisable to keep insurance and investment separate, a term plan should be your first choice among insurance products.  

Who needs life insurance?

Life insurance is meant to replace a person’s income in case of his untimely death so that his family, if it is economically dependent on him, is not affected. A term plan is a must buy for all those who have dependants. If you have liabilities like home loan, car loan, and other debts, term insurance will ensure that your family does not have to bear the burden of repaying them. In short, it acts as a cushion so that your family’s financial needs are met in your absence. 

But if you don't have an income currently or potentially (say, you are retired), or if you don't have dependants (say, you are single with financially independent parents), then you should not waste money on buying life insurance. You can always buy it later when the situation changes—when you start earning or get married. 

Select the right term policy 

There are three main aspects to selecting the right term insurance plan: choosing the right product, the right amount of life cover, and the right tenure.

Claim settlement ratio must be high:  A good term insurance product should have competitive features. The insurance company providing it should have a high claim settlement ratio—in the range of 97 per cent or more. This means that more than 97 per cent of the claims made were paid out by the company. 

Another important parameter is the speed of processing claims. You wouldn’t want your family members to keep waiting for the money to come in. A period of around three  months is good. Check these details on the insurer’s website or on that of the Insurance Regulatory and Development Authority of India (IRDAI). 

Don’t underestimate the cover required: Typically, most people underestimate the life cover they need as they fail to take into account their current liabilities properly. As a result, their families end up in financial hardship even after having insurance. You can estimate the right amount of life cover for yourself using one of two methods — income replacement and expense method.

In the income method, you estimate how much you are going to earn over your lifetime and then what that amount is worth today after adjusting for inflation. In short, this is the financial worth of your life and you should buy a life cover amount equal to it. A rule of thumb you may follow is that your life cover should be 15-20 times your annual income if you are in your thirties. For example, if you earn Rs 10 lakh, your life cover should be around Rs 1.5-2 crore.

In the expense method, you calculate how much your family is going to need in your absence for living expenses, to pay off outstanding loans, and to meet expenses such as children’s education and marriage, etc. Add up all these to arrive at the life cover required. This is a more detailed way of calculating the required life cover, but it will also give you greater peace of mind. You may consult your financial advisor or use an online calculator to estimate the amount of life cover using the expense method.

Don’t go for unnecessarily long tenure:  This is an under-rated but important aspect of selecting the right policy. Generally, people have the tendency to go for the maximum tenure, but doing so will only increase your premiums unnecessarily. Life insurance is taken to protect your income stream in the event of your death, so you should take life insurance only till the time you will work for an income, i.e., till your retirement age, and not until you are 100 years old. If someone is 30 today and expects to retire at 65, he should take life insurance only for 35 years as after that there will be no income that will be lost in case of an untimely death. 

Choose an appropriate payout option: Term insurance products now allow you to choose from a range of payout options. You can choose that your family gets a lumpsum amount at one go, or a monthly amount, or some other combination. Here, it is generally preferable to get the entire money in one go as the lumpsum can be used to clear off debts at that point. Also, the lumpsum can be invested to get a better monthly payout than what the insurance company would give you.

Buy separate policy instead of rider: Generally, availing of riders is not necessary, especially because current products have already incorporated benefits like critical illness payout in the base product itself. But you may still want to go over the riders with your financial advisor. In general, it is better to take a term insurance, a health insurance and a separate personal accident insurance policy, instead of trying to buy a rider for it. Riders are generally expensive and offer limited coverage.

Mistakes to avoid  when buying term cover
 

•  When calculating the amount of cover, include all the people currently dependent on you, including your earning spouse if their income is inadequate
•  Include all your existing loans, especially long-term ones, like home and car 
•  If you use the expense method, take into account inflation 
•  If you use the income method, take into account income growth
•  Instead of choosing a term plan that covers you till you are 80-90 years, choose a higher cover till the time you plan to work and earn

The writer is co-founder and chief investment officer, Goalwise