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Term plans do not return money. But they're still the best insurance product you can buy

I have always maintained that term insurance is the best insurance policy to buy. However, most investors have difficulty in accepting the fact that upon survival (or when the term ends) there is nothing the policy yields by way of maturity proceeds. Just the other day, an extremely upset parent of one of my young clients called up to express his outrage that his daughter was being misled into taking insurance that was totally wasteful! So enduring and widely prevalent is this misconception that this week, I am going to once again explain the concept and demonstrate how term insurance scores over any other kind of insurance plan that one can buy.

Basically you should try and avoid any plan from whichever insurance company that seeks to combine insurance and investment. Such a blend, without exception, 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 policyholder 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 against a policy which at least pays, at the end of the day, either the sum assured or the maturity value? This is the subject matter of this article.

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 bang 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 costs of medical emergencies or hospitalisation. However, if you remain fit and healthy, the premium paid 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 premium is known as mortality premium. It 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, the mortality premium keeps getting deducted every year from the fund value. So once gain, insurance never comes along, you actually buy it, directly or indirectly, year after year.

Let us take an example to understand this concept in depth.

Take the case of a 30-year-old person who desires to buy an insurance cover of Rs 10 lakh. Were he to buy an endowment plan, the annual premium he would pay is around Rs 39,000. However, a term plan would just cost Rs 3,800 per annum for the same amount of risk cover of Rs 10 lakh. This difference of Rs 35,200 between Rs 39,000 and the pure risk cover cost of Rs 3,800 is the called the investment premium. Putting it differently, for a premium of Rs 39,000 per annum, one can either purchase an endowment plan where the sum assured is Rs 10 lakh or one can buy a term plan where the sum assured is around Rs 1 crore. Your choice.

Of course and understandably so, brokers earn a far greater commission if they sell you polices other than the term cover. These commissions, that can go as high as almost 40% are recovered from the investment premium (Rs. 35,200 in the above example) that you pay. And it is an easy sell too since the logical sounding argument given against buying a term cover is why opt for the same when you don't get anything back in the end? But now, hopefully, you know better. Before I end, I do actually have a favourite policy - it's called "Buy term and invest the difference".

Source: http://digital.dnaindia.com/