BackComparing term plans with income benefits
Assess insurance needs, and look at the net present value of income benefit plans for effective comparison
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A term plan is the best and cheapest way to buy a life insurance policy, and it can be bought online as well. As these plans have a straightforward structure—the nominee gets a sum assured on death of policyholder during the policy term and nothing if policyholder survives the term—buying or even comparing premiums is easy. But not anymore: insurers have started designing term policies to offer periodic income that makes the comparison a little more nuanced. Here is what you need to know about term plans that offer staggered benefits.
Income benefit
A term plan promises to pay the beneficiary the sum assured in lump sum if the policyholder dies during the policy term. Income benefit plans, on the other hand, break this sum assured down into monthly payments for a fixed number of years in order to provide regular cash flows to the nominee.
Most plans break the sum assured into lump sum payment and monthly instalment payments for a fixed number of years. Some offer to increase the monthly income by a certain percentage to inflation index your cash flows (see table).
Breaking the insurance money to provide a cash flow stream helps if the nominees is not equipped to optimally utilise the lump sum. “Many people don’t understand lump sum but understand cash flows well and are able to deal with it better. Moreover, the beneficiary may not really be equipped to make effective use of a big amount. In that sense, term plans that break the sum assured into part lump sum payment, which caters to immediate liabilities, and part regular payments to provide cash flows, is a good idea," said Rajiv Jamkhedkar, founder and chief executive officer, The AZAD Program, a financial advisory firm.
But how do you compare these plans? In a plain vanilla plan that offers a lump sum benefit, the basic level of comparison can be on basis of premiums, but plans that offer staggered benefits, premium comparison is more difficult.
Say, you buy plan 1 for 100 that promises to pay your beneficiary 100 every year for 10 years, and plan 2 at the same cost promises to pay your beneficiary 75 for 15 years. The total payout in the first plan is 1,000 and 1,125 in the second plan, and you may be inclined to buy the second plan. But that’s because you forgot to factor in inflation.
Inflation eats into the value of money, which means what you can buy for 100 today, will cost you more than 100 in the future. Even as plan 2 offers a slightly higher payout in the future, it may not really be a better deal if you factor in inflation and time value of money.
For a suitable comparison, you need to look at net present value (NPV) of both the plans. Assuming inflation of 6%, NPV of all future cash flows from plan 1 comes to 736 and 728 from plan 2. This means, plan 1 offers better value.
“Income plans are a very good way to insure the family, as income has far higher utility and benefits compared to a one-time payment. But this makes comparisons a little complicated as each plan has variations. One method to compare premiums is to calculate the present value of all potential payouts," said Yashish Dahiya, chief executive officer and co-founder, PolicyBazaar.com, an online insurance comparison site.
Income replacement
This category of term plans needs greater care when comparing benefits. Typically, these are designed to offer a steady stream of income until a goal is reached instead of paying a fixed sum for a fixed number of years. For instance, child option in PNB MetLife India Insurance Co. Ltd’s Mera Term Plan links insurance benefits with the child’s age. This option is available to a policyholder whose child (beneficiary) is younger than or 15 years of age. It pays 50% of sum assured as lump sum and balance as equal monthly instalments till the child turns 21. For example, it will pay 0.37% of the sum assured a month if the child is less than a year old at the time of death of the policyholder and 4.43% if the child is 20 years old. If the policyholder dies after the child has turned 21, entire sum assured is paid in lump sum.
The other type of income replacement policy, like the one linked to one’s retirement, offers to replace the policyholder’s income, which means that if the policyholder dies closer to retirement, the sum total of payouts will reduce. Take, for example, the iIncome insurance plan from Aegon Religare Life Insurance Co. Ltd. The policy term in this plan is 60 minus your age. The sum assured is decided by your monthly post-tax income. The sum assured or the death benefit is paid as a lump sum (equal to 12 times the monthly income that inflates at 5% every year) and as monthly income (which continues to increase by 5% every year throughout the policy term). If the salary is 1 lakh per month and the policyholder dies in the first year itself, the death benefit will be 12 lakh paid as lump sum and 1 lakh monthly payment, which will increase by 5% every year till 59 years of age of the deceased. If the death occurs in the second year, the lump sum benefit to the beneficiary will be 12.6 lakh (12 times 1.05 lakh), and the monthly benefit will be 1.05 lakh. Monthly income here is paid till policyholder would have turned 60, or for five years, whichever is higher. The premiums in this plan may appear cheaper and that’s because the liability of the insurer decreases with each passing year in the policy so what you need to understand is that as the death occurs closer to maturity, the total benefit payable to the beneficiary reduces. So, if the death occurs right in the beginning of the first year itself, the total benefit for a 30-year-old with a monthly salary of 1 lakh will be around 8.07 crore. If the death occurs say in the beginning of the 20th year, the sum total will be 4.59 crore.
“Income replacement is a good concept, but it might not work for everyone. People protecting against high debts might find a regular online term plan a better option, while those looking to help ensure living expenses and future goals might want to take a closer look at deferred payout or income replacement plans," said Manish Shah, co-founder and chief executive officer, BigDecisions.com.
Also, you need to factor in your age when buying these plans. “As one gets older, perhaps income increases, but one also gets closer to retirement. In such a case, the one-time payout plans start to make more sense. However, this may be for those over the age of 45 or so," said Dahiya.
Term plans are an excellent way to insure yourself and staggered payments add to customisation. But don’t write off the lump sum plans completely.
“Monthly income plans stabilise the family on death of the policyholder. There could be immediate expenses and so a considerable amount of lump sum is needed as well. Plans that offer just 10% of the sum assured as lump sum may not work. Opt for a plan or a combination of lump sum and monthly payment plans for adequate lump sum and monthly payments," said Suresh Sadagopan, founder, Ladder7 Financial Advisory.
Take advice from a planner to assess your insurance needs and look at NPV of income benefit plans to properly compare the premiums.
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