When we are growing up and we are dependent on our parents or guardians, we don’t really see the risks in life. Getting an allowance and managing our expenses with that allowance seems like a simple, straightforward thing. Life is all rosy till the time we grow up and start shouldering the responsibilities. It's only when we start earning and have dependent loved ones to take care of, we start sensing the presence of risks in life. What if I am not there tomorrow? Will my loved ones be able to take care of their expenditures? Will they be able to maintain the same lifestyle which we are living at present? Will they be burdened with the debt obligations I have? However unpleasant these thoughts are, we need to think about them and find our answers. As they rightly say, “You don’t buy life insurance because you are going to die, but because those you love are going to live.”
We often learn in our school days about how animals provide for rainy days, how they set aside food so that they can survive the rainy season without hunting for food etc. In the context of financial planning, ‘Providing for rainy days’ rightly stands for setting aside resources for tough days. In a world full of risks and uncertainties, one can lose a job, suffer losses in business, may get injured, may undergo medical treatment for a long period or a pandemic may hit the world and all these events may hinder the income flow of the earning person. If you have set aside contingency funds, you can take care of expenses of your loved ones despite the abrupt halt of income flow. Sooner or later you can resolve the issues on hand and resume earning. But what if you are not there tomorrow? Can the contingency funds take care of education for your children? Can your family continue to stay in their home and pay the mortgage? Will your spouse continue to manage home expenditures without your income being in place? To have that considerably large contingency fund, you need to start saving at a very early age and choose asset classes which can give you good returns year on year consistently. It is not impossible but it will be rather difficult if you do not start early. So what can you do to secure your family against risks which can affect them if you are not in the picture? Buy an appropriate life insurance coverage for yourself.
Let’s understand life insurance in simple terms. There is a town where 100 people are living. Each person contributes $1 per month and the town creates a fund of $100 in a month. One day one of the residents passes away due to an accident. His family has no income source and needs money to survive. The village gives certain funds to the family so that they can take care of their expenses. And the residents continue to contribute to the village fund every month so that the same fund can help their families in case of their untimely demise. The concept of ‘life insurance’ is as simple as that.
Now let us go a little deeper and understand what the different types of life insurance are.
There are three main types of life insurance: Term life, Whole life and Universal. Depending upon the type of your life insurance policy, your premium amount and the amount your beneficiaries can expect to receive upon your death vary. It's important to choose the right type of policy to keep your premiums affordable, accomplish your financial goals, and make sure your beneficiaries are taken care of if something happens to you. For this to work, you should know some simple nuances of different types of life insurance policies which can fit your requirement.
Before we look at different types of life insurance policies, let us get familiar with some keywords.
Premium is the periodic payment made towards the insurance policy so the insurance cover remains intact. These are either done on a monthly, quarterly, semi-annual, or annual basis.is the periodic payment made towards the insurance policy so the insurance cover remains intact. These are either done on a monthly, quarterly, semi-annual, or annual basis.
Beneficiary is/are the person(s) designated by the policyholder who will be receiving the death benefit.
Death Benefit is the amount received by the beneficiaries after the death of the policyholder.
Claim Filing is submitting the necessary paperwork to get the life insurance pay-out is called claim filing. It usually requires proof of the death of the deceased and proof of identity for the beneficiary.
Exclusions are disclosures in an insurance policy that clarify coverage and explain under which circumstances the benefits will not be paid out to the listed beneficiaries.
Coverage is the amount of risk or liability that is covered for an individual or entity by way of insurance services.
Term life insurance policies are generally the most cost-effective insurance coverage, as you get a large coverage for a much lower premium as compared to other types of policies. Term life insurance policy provides coverage for a predetermined number of years. This type of life insurance only pays a death benefit if the policyholder dies before the term is up. It doesn't accumulate cash value that can be used for loans and other purposes. Once the term is complete, a term policy has no value. However, it can be an affordable option for parents who want to ensure their children are provided for till they grow up or for individuals who want to leave a legacy for a charity cause.
Unlike a term life insurance, a whole life insurance is a type of permanent life insurance that remains in effect for as long as you keep paying the premiums. You can pay premiums in one lump sum, monthly or annually, depending on the policy.
Whole life policies carry a death benefit and a cash value, which is a tax-deferred savings account that is included in the policy. The cash value accrues interest at a predetermined fixed rate. Each month, a certain portion of your premium will go into the cash value of the policy, which offers a guaranteed rate of return. The policy's cash value grows over time and can be withdrawn when it accumulates enough value or can be used for a loan which in most cases is income tax free and zero net cost, as the loan earns interest while outstanding.
Universal life insurance is another type of permanent life insurance that accumulates tax-deferred cash value. Universal life – also called adjustable life – is more flexible than whole life. For example, you may be able to increase the death benefit or change your premium payment amounts or the payment schedule. However, universal life is more expensive than term and more complicated than term or whole life insurance.
As explained in the previous section, depending upon your requirements, you need to choose between a term life insurance and a permanent life insurance. If you choose a term life insurance then you will have to get answers to a few questions:
How much policy coverage do you need?
How long do you want your policy’s term to last?
How much coverage you are eligible for as per the insurance provider?
How much policy premium fits your budget?
To determine the answers to the above questions, you should know the reason for which you are buying the life insurance. E.g. If you have recently bought a house and your mortgage is 20 years long then you may want to go for coverage sufficient for your loan obligation and policy term of 20 years or more. Though a policy term matching the mortgage tenor would suffice, you may want to keep a cushion in case you opt for refinance and tenor change for mortgage in future. Another example could be that you are buying term life insurance because you have recently become a parent, then you may like to go for a term length of 30 years so that in case something happens to you then your child’s upbringing, schooling and graduation fees requirements are taken care of. In this case, the coverage amount can be estimated based on the present education expenses with the help of your financial advisor. You may also want to take stock of your expenses, financial goals and liabilities to determine how much you can spend on an insurance policy premium to get the optimal coverage. Generally, as a rule of thumb, higher the coverage amount and longer the policy term, higher will be the premium you pay.
Apart from the aforementioned points, your coverage amount and policy term also depend upon your eligibility calculated by the insurance company. Life insurance companies would check if you financially qualify for the amount of coverage you’re asking for. The insurance company takes your age into consideration to determine how many years you have before you retire and will no longer make an income or have dependents.
In general it is recommended to go for an optimal term i.e. term longer than your financial obligations or requirements. Why? There is a famous quote by Eleanor Roosevelt saying “Today is the oldest you’ve ever been, and the youngest you’ll ever be again.” The insurance premiums increase as you grow older as the risk of ailments and eventually the risk of death also increases with the age. So if you buy a 20 year term to cover your mortgage of 20 years and during the term if there are any life changes such as birth of a child then to increase the coverage or the term, you may have to pay a much higher premium depending upon your then age and then health conditions. On the other hand, you can buy a longer term policy and if in future you do not need the life insurance coverage then you can lower your coverage amount without going through the underwriting again or cancel the policy altogether.
Ascertaining the reason why you want to buy a life insurance policy is half way through the process of buying insurance. For the remaining half of the process, you need to compare quotes of various life insurance policies meeting your criteria. You may either do it on your own by visiting individual insurance company websites or seek professional advice from insurance brokers or may opt for online portals of insurance service providers such as Inszu which have partnered with multiple insurance companies. To obtain the insurance premium quotes on online portals you may have to key in some basic details like gender, age, smoking habits, current medications, health history, occupation etc. You may have to choose the coverage amount you are looking for and the term length if you have interest in term life insurance. Based on the information you have keyed in, the quotes will show your possible premiums and the amount of coverage you will receive from various insurance companies to help you determine the right policy for you. Most of the people pick the cheapest policy that has the coverage they need. However, it’s important to compare other features, like company’s claim paying abilities, claims history, what riders a company offers, their customer service and other ratings, and whether or not they’re best for your particular health profile. You may also go for insurance providers which do not warrant a medical examination and provide hassle free insurance solutions. Based on these points, you need to compare insurance providers to find the best life insurance company for you.
Irrespective of the insurance policy you buy, you should read the policy documents carefully and note the exclusions clause of the policy in order to ensure that in your absence, your policy benefit gets transferred to your loved ones seamlessly. Life insurance companies may withhold the death benefit if they find inconsistencies in the information provided, if the insured person dies while participating in risky activities, if the insured person is murdered by the beneficiary or the insured person commits suicide within the contestability period of the policy etc.
Some of the prominent and reliable insurance providers include companies like Allianz, Mutual of Omaha, Foresters Financial, North American, Transamerica, Sagicor etc. These are the service providers with satisfactory financial strength ratings and also hold great claim paying abilities.
When it comes to buying an insurance policy, there is a cost of delay, cost of misinformation and there is a cost of adverse selection as well. Choosing a correct policy which fits in your budget, provides optimal coverage in line with your financial goals is of utmost importance. Choosing the right policy option ensures protection of financial interest of your loved ones in case of your untimely demise. In addition to making the right choice, one also needs to keep servicing the policy throughout the policy term by timely payment of premiums. Also, while applying for insurance policy, even if being honest means you end up paying higher premiums or there are exclusions in your policy, it’s important to be completely honest. Not doing so can jeopardize your beneficiary’s ability to collect the death benefit.
Overall, risks cannot be avoided as they are part of life. But they can surely be mitigated and planned for, so that our loved ones have a secured and better tomorrow. Get insured!