Deepesh asks, “I calculated the term life insurance cover required for me to be close to two crores. However, I doubt if I will get this cover given my current income profile, even if I’m willing to pay the associated premium. In such a case, should one consider buying a term plan with increasing cover?”
How does an increasing term insurance cover work? These policies come with a 5% annual increase in sum insured (SI) until it becomes double the original sum insured. For examples, if the SI is 100 lakhs (1 crore) in the first year, it will be 105 lakhs in the second year, 110 lakhs in the second year, and so until it reached 200 lakhs (2 crores). After this, it would remain constant.
At first sight, this seems enticing. Then the insurer would say, you can fight inflation this way. The catch is the cost. Since the risk of higher payout increases each year for the insurer, the premium for 2 crores sum insured will be charged from day one. We would be paying a premium corresponding to a two crore term plan for several years (for the first 14-15 years in the above example), while the actual SI would be less.
From the insurer’s point of view, this higher premium is necessary to cover the cost of increased risk, but it is an unnecessary expense from our point of view. The insurers would argue, if you buy a one crore policy first and then buy another one crore policy 10 years later, the effective cost would be more. While this is indeed possible, there is no need to be paying an extra premium from day one.
Suppose you have just started working, and your net worth is essentially zero. You buy a one crore term insurance cover. This means the effective net worth of your nominee is one crore (assuming they are totally dependent on you). Even if your income is low, can you not increase your net worth each year by 5% simply by investing each month and increasing this investment each year?
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This way, your nominees net worth effectively increases about 5% each year with one crore as the base. If you factor in return on these investments, the increase in net worth each year would be a comfortable 5-10%.
By simply paying your first, by simply investing each month (or whenever possible) in a disciplined manner, you can easily beat the “benefit” of an increasing term life insurance. Plus, the premium cost is also lower.
If you become a parent, you can always buy another plain term insurance if necessary. Even if you have an increasing term life cover, the annual increase would be too small to accommodate a child’s future needs, meaning you still need to buy additional cover!
Therefore, please buy a simple term insurance cover for the maximum amount the insurer is willing to provide for your income levels and focus on increasing your net worth aggressively. This would comfortably beat the benefits of an increasing term insurance cover.
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