One of my friends asked, “Should I Buy term insurance cover till I reach 85 years of age, to get a guaranteed payout?” and another friend asked “Should I opt for limited payment term? It will save me a lot of money.”
The answer to both of these questions is ‘Yes, You Should!!’.
But it can be so, only if there is no concept of time value of money. Consider
the value of money in calculations and you will get an answer that’s opposite
to what a simple calculation will denote.
To explain this, we have launched a 3 part series of
Ingredients to a perfect recipe – Term Insurance, wherein we will analyze all
the important things to consider for ensuring you family’s financial security.
What is Time Value of money?
The price of a material may change in future, these
changes may increase or decrease the value of money. This concept of change in
value of time is called time value of money. For eg. you may buy sugar for Rs.50/kg
today, however, after one year if the cost of sugar increases to Rs.55/Kg, for
same Rs.100, you can buy only 1.8Kgs of sugar. Thus, the value of same Rs.100 can
be said to have reduced due to inflation. This is an example of Value of money.
Why to consider Time Value In
Insurance?
Insurance as a product is generally long term in
nature. Term insurance can go upto 50-60 years in future. Considering this, it’s
important to consider the impact of time value on your premiums and maturity/Sum
assured.
For eg. If you take a term insurance with cover of 1Cr,
it may seem enough today. However consider that if a claim is to be made by
your family after 30 Years, though they will get Rs.1Cr, would it be enough? The
present value of that 1Cr after 30 Years would be Rs.17Lacs at an inflation of
6%. This basically means, if there is an inflation of 6%, your family can buy
the same goods after 30 years for Rs.1 Cr that they can buy today for 17Lacs.
From the above example, you must have realized how
time value works with insurance cover. Similarly, it works with the premiums
you pay to get this insurance cover. Let’s check that out.
For calculations we are considering term insurance
premium for 1Crore cover for a 25Year old healthy non-smoking male for cover of
40 Years from Max Life insurance.
There are three plans that the insurance company offers. Pay for 45 years, 35 years or 10 Years with varying premiums, as shown below.
|
Premium Chart |
||
|
Premium |
Payment Term |
Payment type |
|
9,450.00 |
45 |
Regular Pay |
|
10,100.00 |
35 |
Limited Pay - 35 Years |
|
22,046.00 |
10 |
Limited Pay - 10 Years |
Normal calculations will show that you need to pay Rs.4.25Lacs,
Rs. 3.53Lacs and Rs. 2.20 Lacs in regular pay, 35 years pay and 10years payment
plan. So the decision would be outright to take limited pay 10 year plan.
But now let’s consider present value. At an inflation
of 6%, the present value of total premiums paid is Rs.1.55Lacs, Rs1.55 Lacs and
Rs.1.72Lacs respectively. You can refer to the calculations here.
The thing to understand is that insurance company will
never offer you a discount for providing the same cover. Infact, to exploit the
lack of knowledge, companies actually charge a premium for short duration
premium payment plans, as people often ignore the important factor of time value
of money.
This concept works in the same manner in case of Long
tenure term plans, and I will share the calculations on the same in my next
part of this series.
Tips to Buy Term Plan:
1. Buy the policy with regular pay, in this way, if the claim is made midway or the policy is no more needed no more premiums are required to be paid.
2. Don’t buy term insurance for age beyond 65-70 if you think that your liabilities will end by then.
While buying insurance is an extremely personal subject and the needs and each person’s requirement is different. You can make any choice, as long as you are aware of the choices you are making, 'Kyunki Paise ped pr nhi ugte'.
You can use
this sheet for calculations on your own or let us know for any queries
regarding term insurance at our email or drop a message us @Money.Matrs.
To invest in equities, bonds and other instruments,
you can open a demat account with Upstox by clicking here.
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