Jan 30, 2010

Should you split your term life insurance coverage?

Photo by simpologist

Few days back, an anonymous reader asked me the following question (see: 4 unknown facts about term plans):

Can I take two to three term insurance policy say one from sbi, second one
can be from birla and third can be from hdfc??Is it advisable to do so?


Contrary to the usual advice—that it is always better to split your life insurance cover into two or more policies as it imparts flexibility to your insurance cover so that if in future your insurance requirement decline, you can make a safe exit from one of the policy and thereby save considerable premium—this post is going to
prove otherwise:

Why single policy with a higher sum assured is better than two or more policies?

Let’s assume you are 35 years old and have decided to buy a term insurance plan of Rs 40 lakh for 25 years. But you’re not able to decide whether to go for a single term plan or buy two policies by splitting the coverage in the ratio, say, 50: 50 (i.e., each policy of Rs 20 lakh) , or approximately 60:40 (first policy 25 lakh and second policy for 15 lakh), or around 70:30 (first term plan 30 lakh and second term plan for 10 lakh) so that if need arises (i.e., your life insurance coverage requirement declines in future) you can make a exit from one of the policy.

So you decide to evaluate which choice among the following four is most suitable:

Case 1: Single term plan of Rs 40 lakh
Case 2: 1st term plan of Rs 30 lakh and 2nd of Rs 10 lakh
Case 3: 1st term plan of Rs 25 lakh and 2nd of Rs 15 lakh
Case 4: Two term plans of Rs 20 lakh each

Further let’s assume you’ve decided to buy a term plan either from HDFC or ICICI. Please note that ICICI life insurance companies offer you two variants of the term insurance plan. While ICICI Pru Pure Protect Classic provides coverage up to 24.99 lakh, ICICI Pru Pure Protect Elite takes care of coverage beyond 25 lakh.

Notes:
1. The premium figures are as per Bimadeals.com (I hope the premium rates are correct. Anyhow, even if not correct or if there is any future change in the premium, should not significantly affect the crux of the analysis).

2. I’ve only considered one case study assuming three different scenarios; there could be numerous permutations and combinations. So, you can do the same exercise according to your specific needs. For example, if you would like to opt for 15 years for second term plan instead of 20 years considered in the above example, the entire calculation will change.

3. Time value of money is ignored.

4. There are three scenarios: zoho sheet 1 covers first two and sheet 2 covers the third one.




What do we observe?

Scenario-1:All the policies are continued till maturity
Splitting the policy involves extra cost as follows:

a. Single term plan of Rs 40 lakh --> NIL
b. 1st term plan of Rs 30 lakh & 2nd of Rs 10 lakh --> HDFC—Rs 34,550; ICICI— Rs 27,100
c. 1st term plan of Rs 25 lakh & 2nd of Rs 15 lakh --> HDFC—Rs 49,750; ICICI— Rs 40,650
d. Two term plans of Rs 20 lakh each --> HDFC—Rs 49,750; ICICI— Rs 1,08,400


This extra cost is involved if you don’t make a premature exit (as planned) and both the policy run for the entire tenure of 25 years.

Scenario-2:Decision to exit second Policy (i.e. lower value policy) is taken after 20 Yrs
Now let’s consider another scenario where after 20 yrs you feel that your life insurance need is reduced and decide to make an exit from the lower value policy while the higher one will go for entire 25 years.

Extra Cost involved:

a. Single term plan of Rs 40 lakh --> NIL
b. 1st term plan of Rs 30 lakh & 2nd of Rs 10 lakh --> HDFC—Rs16,345; ICICI— Rs 5,300
c. 1st term plan of Rs 25 lakh & 2nd of Rs 15 lakh --> HDFC—Rs 22,855; ICICI— Rs 7,950
d. Two term plans of Rs 20 lakh each --> HDFC—Rs 14,165; ICICI— Rs 64,800


So even if you give up one of the policy and reduce your risk coverage, you end up paying more premium. In other words, here also buying one consolidated term plan scores over splitting the term plan.

Scenario-3: Decision to exit second policy after 20 years made right at the purchase stage.
Further there can one more scenario where you’re sure right at the time of buying the policy that the lower value policy is required only for 20 years (so buy it only for 20 years instead of 25 years) while the higher one will go for the entire 25 years. Now let’s see does it make any difference and help you save premium outgo:

Extra Cost / (Savings) involved:

a. Single term plan of Rs 40 lakh --> NIL
b. 1st term plan of Rs 30 lakh & 2nd of Rs 10 lakh --> HDFC—Rs 8,425; ICICI— (Rs 3,300 )
c. 1st term plan of Rs 25 lakh & 2nd of Rs 15 lakh --> HDFC—Rs 10,975; ICICI— (Rs 4,950)
d. Two term plans of Rs 20 lakh each --> HDFC—(Rs 1,675) ; ICICI— Rs 47,600


Here also you pay more in 3 out of six cases while there is very negligible saving in other three.

Finally before wrapping up the discussion, let us consider one more possibility. What if the policyholder die (please don’t mind) after, say, 22 years? The nominee will receive the following insurance proceeds:

Case--------Scenario 1----Scenario 2-----Scenario 3
1. ---------- 40 lakh--------40 lakh---------40 lakh
2. ---------- 40 lakh--------30 lakh----------30 lakh
3. ---------- 40 lakh--------25 lakh----------25 lakh
4. ---------- 40 lakh--------20 lakh----------20 lakh

I hope you got the point.

Further, please also note the following points:

1. It is always better to be over-insured than under-insured.

2. More the number of policies, more the hassles (documentation, premium payment, filing claims).

3. A life insurance with a sum assured of 40 lakh will provide coverage of just 12.47 lakh in real terms (assuming a nominal inflation rate of 6%) after 20 years. In other words, the real worth of Rs 40 lakh after 20 years will be equivalent to Rs 12.47 lakh in today’s money if the average rise in prices of goods & services is 6%.Put another way, after 20 years the real worth of your policy would be roughly 1/3rd at inflation rate of 6%, 1/4th at 7% and around 1/5th at 8% respectively. Do you still need to lower your coverage any further?

The point worth noting is that there won’t be any need to scale down your insurance cover in future. Inflation automatically takes care of it.

The above discussion proves that in majority of cases single policy (pure term plan) with higher sum assured is better than two or more individual policies. Put another way, splitting your life insurance cover (with or without splitting the tenure) doesn’t work.

What do you think? Do you agree? Do you already have multiple policies? Or, were you thinking of splitting your life insurance cover? Please share your views.


Also see:

1. Most amazing fact about life insurance
2.
4 Things you don’t Know about term plans
3.
Term insurance plans - FAQs

13 comments:

  1. Have you checked the iterm plan from Religare.
    Its the best in business so far.

    Rakesh

    ReplyDelete
  2. Good Article Fisher... However, along with this, can you stress on the point of disclaimer in the Policies ? What kinds of deaths are considered for paying the the insurance amount and also comparison against LIC ?

    ReplyDelete
  3. Samant: This post considers only one aspect: Does splitting your insurance cover make sense? Policy exclusions are a completely different topic. Further for the purpose of comparison I’ve chosen two term plans at random. If you wish you can do the same exercise for LIC term plans also. I don’t think the results will be any different.

    Rakesh: This post is not about cheapest term plan.

    ReplyDelete
  4. This comment has been removed by a blog administrator.

    ReplyDelete
  5. Hi Rehan,

    Many thanks for disclosing your identity.

    It is always better to be completely honest (even if your agent advises you otherwise) while filling up the form instead of facing problem at the time of claim.

    ReplyDelete
  6. Sorry Rehan, I had to delete your comment due to some technical reason.

    ReplyDelete
  7. Hi Mr. Fisher
    As usual informative and thanks for the link to Bimadeals.com.

    regards,
    Hari

    ReplyDelete
  8. Dear Mr.Fisher,

    A very nice and informative article. I would like to know how to calculate exit from a policy. I would like to take your advice and move to a single policy from 3 policies which I hold. I am planning to exit from all the three. I would like to know what will be the "loss" from those exits.

    Krishna
    http://www.keepwrite.com

    ReplyDelete
  9. Here is one more aspect you need to consider.
    If you are considering to buy a large sum assured policy, it might make sense to split the sum assured in two and buy two term plans from different vendors. This would basically hedge your risks of depending on single Insurance company for claims. Just in case one of your claim gets rejected, you still have chances of getting your claims from the other.

    Diversifying your risks helps!

    This is what I have personally done. Split my Life cover with LIC and Birla Sun Life.

    ReplyDelete
  10. Noting Puneets comment Mr Fisher do you think its a good thing to do to buy 2 policies to "hedge your risks of depending on single Insurance company for claims. Just in case one of your claim gets rejected, you still have chances of getting your claims from the other."

    MB

    ReplyDelete
  11. Is there something in law that a person taking more than one life insurance policy (for now focusing on term plan) has to declare to each insurance company about his/her other policies.
    and in case of this is not done , while going for claim the insurance company has the right to reject your claim on this basis only that you have not declared other policies.
    I saw one program on Sony (Crime Petrol) where they showed a case of a person taken many policies and after his death his family got rejection from insurance companies and those companies threaten them for filing a case against the decease family as he hadn't declare all the policies.

    ReplyDelete
  12. Hi,

    First of all thanks for the good work.

    I've a online term insurance from Aegon-religare with a premium of 11471 Rs/year for a coverage of 1 Cr for 25 years.

    However now I am feeling it's less so I am also planning to buy another online term insurance of 2 Cr for 35 years from Aviva i-life.

    Could you please answer following:

    - Is it right to buy from another insurer or should I ask Aegon religare to increase my coverage?

    - Do I've to declare to Aegon religare / Aviva that I've bought another online term insurance?
    policy?

    What's the best way to handle this kind of situation?

    Any response to the query will be highly appreciated.

    Thanks,
    Rachit

    ReplyDelete
  13. you can declare you policy details to insurance companies. I suggest that be very honest while filling up your details and ensure that your nominee is aware of all the documents and procedures. Mere taking a policy does not help. I have heard of cases where nomineed did not even file for claims as they were not made aware of it.

    Sid

    ReplyDelete

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