India Markets closed

Don’t fall in the “Discount” trap! When buying Term Insurance Choose Longer Payment Terms

Brijesh Desai

Who doesn’t love a discount? Our country is especially famous for discounts, especially in consumer goods and services. On products that you can consume in your daily life discounts means more money in your pocket, or in other words more savings.

However, all the discounts may not mean the same thing, especially when it is about something as important as a term insurance plan.

What is Term Insurance Plan?

Term insurance is a financial instrument, which offers financial security to your dependents, in case anything happens to you (or the insured). On the financial needs pyramid, term insurance is one of the essentials for anyone earning money.

It is also one of the most basic forms of insurance. Meaning, there’s no investment or maturity value component in a term plan. Premium is nominal and offers benefits only on death or disability.

What is a Discount on Term Insurance Premium?

While buying term insurance plans, some of the insurers and advisors end up recommending a shorter premium payment option while coverage term of the plan being 35-40 years. These advisors/insurers show savings on your premiums as a discount when you opt to pay for 5/10 years.

For example, for a male aged 35 years opting for a Sum Insured of Rs. 1 Cr for coverage till age 70 years, the options available would be (average premiums for top 3 brands)

  • Pay Rs. 1,300 every month till age 70 years OR
  • Pay Rs. 2,800 every month for the next 10 years

By opting to pay for 10 years, you end up paying Rs. 3,36,000 during the lifetime of the policy (Rs. 2,800 X 12 months X 10 years) vs paying Rs. 5,46,000 (Rs. 1,300 X 12 months X 35 years). This means a saving of Rs. 2,09,700 on your total premiums paid. This is also marketed as a ~38% discount on your total premium (Rs. 2,10,000 discount on total premium payable of Rs.  5,46,000)

The second option, sure sounds more attractive, as it seems to save about Rs. 256,000 for you. However, there are few aspects invisible to the untrained eyes.

  • First, we have completely ignored the “time value of money.”
  • Second, we also ignore the fact that you are locking yourself for the next 25-30 years and paying a full premium despite the uncertainty of life.

Is the Discount Real?

For the insurer? Yes. For the investor? Not really.

For the insurer, single pay premium means all the money that was receivable in the future is available now. They can invest the money now and earn something in the additional collection. Thus, they can afford to give a discount on the total receivable amount.

In our example above, by opting for a 10-pay option, you end up paying ~Rs. 1,500 extra every month (Rs. 2,800 minus Rs. 1,300) for 10 years. This additional 1,300 per month could have been easily invested in a large cap equity mutual fund to generate long term returns of 8% – 10%.

Even at 8% p.a. return, this investment of Rs. 1,500 per month would have fetched you Rs. 2.7 Lacs at the end of 10 years. Further had you stayed invested with this corpus for another 25 years (during the tenure of your term insurance plan), this would have become a corpus of ~Rs. 19 Lacs by the end of the 35th year (when you would have turned 70 years).

Additionally, assuming that the insured will survive full policy tenure.

Does it make sense even for the customers who do not have steady long-term income flow?

Not much. Remember, the premium for a term insurance plan is fixed and will not change throughout the coverage term.  Your monthly premium in our example above of Rs. 15,000 per month will be the same till you turn 60 years.

Once again, the time value of money makes a difference.

After 20 years, when your turn 55 years old, even at an income growth rate of ~6%, this premium will be equivalent to Rs. 400 per month today (Discounted value of the premium owing to income & inflation growth).

By the time you turn 65 years old, this monthly premium will be equivalent to Rs. 226 per month today (A premium amount that you can simply afford without sweating).

Then why pay the insurance companies more money now.

Then Why do the Insurance Companies promote it?

Well, just one reason. It allows the advisors and marketers to get more money from you at the purchase. It helps them recover the expenses incurred on commissions and marketing costs faster, and they can further profit by investing your excess premiums.

We work hard to earn money, usually with one goal in mind, “to be wealthy enough to afford the life you always wanted.” But we end up ignoring the most important rule in the financial world, “Compounding or Time Value of Money,” in most of our financial decisions.

So, What Should You Do?

Go for a longer payment tenure. The premium payment tenure for your term cover should at least go up to your retirement. This will have more benefits than just the financial ones. For example,

  • Premiums would be more affordable
  • You can stay updated about the policy
  • Enjoy tax savings every year, and more importantly
  • Your family will likely remember that you have a term cover when they need it the most

Disclaimer: This article has been written by Anisha Arora and do not necessarily reflect the views of the Free Press Journal.