Term policies with increasing cover are suited for families with limited financial resources.
Term plans are increasingly finding favour with insurance seekers due to various factors. For one, they are quite simple to understand. Also, they are the cheapest means of life insurance. More recently, another variant of this plan – increasing term insurance – is catching up. These are policies where the sum assured of the insured rises by 5 to 10 per cent every year of the tenure, thereby providing more security to the family.
Such policies are suited for young families with limited financial resources and increasing liabilities.It helps them to meet rising insurance needs due to changes in family size or composition, under the same plan.
There are several advantages of such policies. They are a good hedge against rise in cost of living for dependents. With inflation consistently eroding the wealth of an individual, an increasing term plan could prove to be just the right weapon.
For instance, if a person wants to provide for an income of Rs 20,000 per month (pm) for his family for the next 20 years, this can be achieved with a life cover of at least Rs 30 lakh today. At the end of five years, at an inflation rate of 10 per cent yearly, the same Rs 20,000 pm would be Rs 32,000 pm, and the cover required would grow to approximately Rs 50 lakh, without considering any increase in standard of living.
If the same person had opted for an increasing term insurance, at 10 per cent for Rs 30 lakh, the cover available at the end of five years would be Rs 45 lakh. These policies do not offer an increase in the sum assured on a compounding basis, but only on the initial sum assured. However, the increased sum assured is close to the increased corpus required.
The second advantage is guaranteed insurability. Good health is key to getting insurance at normal rates without attracting any loading for health-related issues. With increasing age, if an individual wishes to enhance life coverage, it may come at higher rates than earlier. This disadvantage is taken care by the increasing term plan, as the individual can enjoy an enhanced insurance cover every year without any additional health check-ups or loading.
The third advantage is compensation for missing on any saving for goals. Prudent financial planning means an individual saves every year for his goals and, thereby, the insurance cover required (in the absence of any increased liabilities) would reduce progressively year-on-year. But with growing uncertainties, individuals can miss their savings target for a particular year.
The increasing term plan protects the policy holder from this loss. The incremental coverage can act as the compensation for the savings missed, thus securing the dependents for any shortfall in savings and investments.
However, all is not well with these products. In terms of costs, there is a higher present outgo, as compared to level term plans. Most companies offering the incremental term plans in India, including the likes of SBI Life Insurance, Aegon Religare and Birla Sun Life Insurance, have opted to charge for these policies on a level-premium mode instead of a stepped-up mode.
In other words, the premium an individual pays for these policies remains constant through the term, though the cover keeps increasing. Obviously, the premium under such plans would be higher than the basic term plans which do not offer any increase in cover.
This could be perceived as a disadvantage, as the premiums paid are not in proportion to the level of cover enjoyed, at least in the initial years.
To illustrate, the premiums offered by the Birla Protector plan for a male aged 35 years (sum assured Rs 20 lakh and term 20 years) is Rs 4,920 for the level-term plan, Rs 6,590 for an increase at the rate of five per cent and Rs 8,270 for an increase at the rate of 10 per cent.
Thus, the policy holder pays an additional premium of Rs 3,350 (for the 10 per cent option) right from the first year, although he enjoys a cover of only Rs 20 lakh in the first year.
Another disadvantage is the lack of flexibility. One cannot reduce the cover at a later date. Third, if the premiums on this policy are not paid in time or within the grace period, and the policy lapses, the reinstatement would be done with the increased sum assured at that point in time, in line with the percentage increase the policy holder had first wanted.
The writer is a certified financial planner
