Term insurance is the best life insurance

Source: The Hitavada      Date: 25 Jun 2018 12:36:19



Life insurance is a necessity – make no mistake about this. However, it is not an investment. In other words, there is no substitute for life cover, none whatsoever. It is the only means of providing security to your family against your untimely death or to yourself during your old age. Therefore, the yield on investment per se, to that extent is of lesser importance. The ‘cover’ or ‘protection’ overrides all other considerations. However, note that it is a necessity, if and only if, the demise of the bread winner of the family will put immense financial pressure on the family members left behind. 

However, if that is not the case, you must reconsider your options. Every product has an associated cost and so does insurance. Do not buy a product you do not need. Excessive insurance injures financial health. So never ever buy an insurance product with the sole purpose of saving tax. That would be like meeting a short-term liability with a long-term obligation. The tax payable is your short-term obligation that you have to fulfill for that particular year. However, insurance products are of a long-term nature and you may find that though you may have saved the tax for that particular year, you will be paying for it by way of future premiums for many years to come. A better way to save tax would be to make use of ELSS funds or if you are risk averse, instruments such as PPF or bank fixed deposits (tax saving FDs).

Term Insurance
Now, if you do indeed need insurance, buy it once for all. Perhaps one of the best products of the insurance industry but the least promoted one is term insurance. It is the most economical, efficient way to insure yourself.
Term Insurance covers the policyholder for a desired number of years against death, accident, disability etc -- the same as other policies. In contrast it does not have any maturity, paid-up, surrender or loan values. On occurrence of the contingency, the beneficiary gets the sum assured but on survival, the insured gets nothing.

Most investors have difficulty in accepting this. Since upon survival (or when the term ends) there is nothing the policy yields by way of maturity proceeds, those showing any interest in term insurance are often told that they are making a totally wasteful investment!

However a plan that seeks to combine insurance and investment more often than not tends to be sub-optimal. It is always better to keep insurance and investments separate. All endowment, whole life and ULIPs are examples of combination insurance plans. On the other hand, a term insurance plan has no cash payout at the end of the term. This means if the policy holder were to pass away during the term of the policy, his family will get the sum assured. However, were he to survive he will not get a single rupee. In other words, term cover is pure life insurance and has no cash or surrender value. If this is indeed the case, why favour term insurance as against a traditional endowment or whole life policy which, at least pays, at the end of the day, no matter what, either the sum assured or the maturity value?

The reason is (as mentioned earlier) because basically insurance is a cost. It is a contract (policy) in which you purchase financial protection or reimbursement against a loss or an unanticipated expense. The price paid to purchase such protection is also called premium in insurance parlance. Such premium is payable, year in year out, till you desire protection from the loss. Now, take for instance car insurance. You pay the insurance premium, year in year out, to protect yourself against the financial damage an accident can cause. If you are a safe driver and manage not to damage your car during the year, the premium paid is lost – you don’t get anything out of it. And you are perfectly happy to have done so, so long as you and your car are safe. Or take medical insurance. Again, premium is paid to defray any costs of medical emergencies or hospitalisation. However, if you remain fit and healthy the premium paid on buying the medical insurance is lost. But then again, you do not mind this, do you? Then why should life insurance be any different? But it is. It always has been.

The reason for this is mainly because life insurance premiums come bundled with the pure premium part combined with the part that gets invested on your behalf. The policy is sold more as an investment where the insurance just comes along. However, know that insurance never comes along, it always has to be paid for. In the case of life insurance, the pure premium is known as mortality premium.

Such mortality premium is applicable for all polices, year after year, without any exception, till such time that the life is insured. Even in the case of single premium plans or policies where the premium is payable only for part of the policy term, nonetheless, the mortality premium keeps getting deducted every year from the fund value. So, you end up paying this premium, directly or indirectly, each year. In the case of any other policy, with or without bonus, whole life or endowment, actually the return on assurance component is also nil. However, it gets mixed up with the return on the investment component which could be (depending upon the exact policy) lower than other comparable investment products. Take care of this.

To Conclude: To reiterate, think of insurance as a cost and not an investment. Incur the cost only if you need to. Always buy pure insurance policies and not ones that are bundled with investment returns. Or in other words, buy term and invest the difference.
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