5 Things to Consider Before Choosing a Term Life Insurance Policy


A checklist with text '5 Things to Consider Before Choosing a Term Life Insurance Policy' against a background of financial icons and a life insurance symbol

Term insurance is mostly a one-time buy product, unlike motor insurance, which needs to be purchased very frequently. Term insurance is designed to provide compensation to the family members of the insured in case of the death of the insured due to an insured peril. In general term insurance plans cover all types of death except for those involving fraud, death under intoxication, etc., which come under the exclusions section of the policy.

Term insurance plans are classified as pure term plans and investment-based term insurance plans. The former ones are those that provide only insurance protection to the insured, whereas the latter ones come with investment options in addition to the insurance coverage.

Since you take it infrequently, it is very important to pay attention while taking a term insurance plan. Term insurance plans are usually for a longer period and cannot be easily altered. Any minor alterations, such as change of address, nominee details, etc., could be done with ease.

Still, in case of major changes, such as the terms and conditions of the policy, it would not be possible, and for this, one needs to cancel the existing policy and go for a new policy. In such instances, the premium paid to date would not be carried forward to the new policy and the new policy might come with a high premium, compulsory medical check, a lower sum insured etc. As it is known, term insurance plans are cheap when you are young and would become costly once you become old.

5 Things That you Should Consider Before Taking a Term Life Insurance Policy:

1. Age & Policy Duration

Term life insurance policy should be checked for the duration of the policy, which in turn depends on the age of the proposer. For example, if you are aged 30 years and intend to take a term life insurance policy for 60 years, then it might not be feasible as most insurance companies offer a maximum term of 40 years or till you reach 70 years of age. Therefore, if you aim to get lifelong coverage, then a term insurance policy would not serve your purpose. If you aim to get life insurance coverage till your retirement age or till the time your children are settled, then you should select the policy period accordingly.

In simple words, a term life insurance plan should be taken only for the period you feel you would work and your family is dependent on your income. If you do not have any responsibilities and family dependence, then there is no point in taking a term life insurance policy. This usually happens when you retire, or you reach 65 years of age. Simply put, a term insurance policy is designed to safeguard the financial interests of your family in case of your absence by providing the sum assured in the form of a claim amount.

The other important thing to consider is the sum assured under the term life insurance policy. Sum assured is the maximum liability of the insurer in case of a claim, i.e., the maximum amount that would be paid to your family members or nominee in case of your demise. There is no hard and fast rule to select the sum assured as the requirement may vary from one person to another. The hard and fast rule to select the sum assured is usually up to 30 times your current annual income. This is only an indication of how to select your sum assured, but if you think you need a higher sum assured, then you can convince the insurance company accordingly.

But it is important to remember that the sum assured would be given based on your current income and not future income earning capacity. You can also opt for increasing term insurance plans in which the sum assured would increase every year by a certain percentage so that it would match your income and, at the same time, beat inflation to a certain extent.

2. Mode of Claim Payout

The other important thing to consider before taking a term life insurance policy is the mode of claim payout. Mode of claim payout is the way in which the claim would be payable to your nominee or family members in case of your demise. There are various modes of payments that can be done in a term life insurance policy, such as lump sum payment, income method, or a combination of both.

In the case of the lump sum method, the entire sum assured would be paid in a single payment to the nominee, whereas, in the case of the income method, a certain amount of the sum assured would be paid periodically. Most insurance companies offer a combination of lump sum and income methods. You could get a certain amount as a lump sum and the remaining portion would be paid periodically.

3. Claim Settlement Ratio & Insurance Intermediary:

Claim settlement ratio refers to the number of claims settled by the insurance company in a year with respect to the total number of claims received in that particular year. For example, if the company announces its claim settlement ratio as 99%, it simply means and denotes that the company has settled 99 claims out of 100 reported claims. A higher aim settlement ratio is an indication of the insurance company’s ability to settle claims in case of an event.

However, this ratio does not give any information about the quantity of the claim amount amongst those claims settled. Nevertheless, it could be an indicator of the claim settlement ability of the insurance company. Claim settlement ratio above 95% is considered an acceptable measure amongst the insurance fraternity. One should check the claim settlement ratio of the insurer for the past 3 years before taking a life insurance policy.

The other aspect of this process is selecting the insurance intermediary. The role of an insurance intermediary would be visible at the time of claim settlement, and therefore, for life insurance plans, a trusted insurance intermediary should be in place. Life insurance plans are for a longer period of time, unlike the general insurance plans. Therefore, consider an insurance intermediary who could serve your interests after a long period of time, particularly in your absence.

Individual agents rarely have a long-standing relationship these days due to the heavy competition and other macro factors. Insurance brokers, on the other hand, are gaining traction in the retail insurance business as well and are considered to be the frontrunners in adopting innovative practices to serve their clients. Therefore, you should select an insurance intermediary who could be available to your family members at all times in case of your untimely demise.

4. Solvency ratio & Market reputation:

In addition to the claim settlement ratio, one should also look at the solvency ratio and the market reputation of the insurer. Solvency ratio refers to a company’s cash flow and its ability to meet long-term liabilities and is often considered as a measure of financial health. The higher the solvency ratio, the better the health of the insurer.

The Insurance Regulatory and Development Authority of India mandates that insurers maintain a solvency ratio of at least 1.5 or 150% throughout the year to minimize the chances of going bankrupt. In simple terms, this 150% or 1.5 indicates that the insurer could pay 150 times the amount they’re liable to pay at any point in time. There could be bad years, such as COVID -19 period, when the claim settlement ratio would be high and result in higher claims. This situation could be handled by a higher solvency ratio where the insurer could pay all the claims without going bankrupt.

Since insurance companies deal with investment in addition to insurance, it requires them to maintain a healthy solvency ratio at any point in time. Life insurance companies also provide returns to their customers, which means that they are actively investing the premium to get better returns. So one should consider the financial health of the insurance company before taking a term life insurance policy.

The solvency ratio is a proxy of the financial ratio of the insurance companies. Term life insurance is a long-term contract, and therefore, insurers should be able to maintain the solvency ratio over a long period of time. Customers should also consider the solvency ratio of the insurance companies for the past 3 years before taking the policy.

The other important thing to consider alongside the solvency ratio is the market reputation of the insurer. Insurance companies might be rosy at the time of taking the policy but might create hurdles at the time of claim settlement. One needs to examine the list of documents required for claim settlement at the time of taking the policy. If you find that your family members can manage the list, then you can go ahead with the insurer.

For example, an insurance company might ask your family members to provide your health history for the past 3 years before your death. This might not be needed, or it had nothing to do with the claim, but still, they might press for this document. It is, therefore, important to compare the list of required documents of different insurance companies for claim settlement at the time of taking the policy itself. There could be certain documents that might be required to be submitted at the time of claim settlement, which would not be mentioned in the list of documents required for claim settlement by the insurer.

5. Add-ons:

The most important thing to consider before taking a term life insurance policy is the number of add-ons to be included in the term life insurance policy. Add-ons or riders, as they are called, refer to the extra coverage to the insured, which comes on payment of an additional premium. The premium for riders is included in the base premium of the policy while arriving at the overall premium payable. Riders, once taken, are usually carried on for the entire policy period unless you want to drop them. So, the premium payable would also be throughout the policy period.

Hence, it is important to consider what add-ons are needed carefully and for how many years before taking the policy. Add-ons such as Disability rider, critical illness rider, terminal illness benefit, waiver of premium rider, etc are available on payment of additional premium. It is advisable to note that the riders could only be taken at the time of policy purchase, and therefore, one should decide the required number of riders. Taking all the riders would increase the premium, and similarly, taking less number of riders would decrease the coverage. Therefore, it is advisable to maintain a balance between the number of riders and the premium payable.

For more details on the things to consider before taking a term life insurance policy, please book a call with our life insurance agents at Ethika Insurance.

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Susheel Agarwal

Namaste. I'm Abhinay Nedunuru, a Fellow of the Insurance Institute of India with a passion to make insurance simple and crisp. I write on insurance and investment. I have a passion for teaching and training in particular to insurance. I'm currently doing my PhD from IIM in Management.