Policyholders are spoilt for choice when it comes to life insurance policies: First is the array of products on sale— they need to choose the policy that best suits them. And then there is the frequency of premium payment—monthly, quarterly, half-yearly or yearly. In case of life insurance policies, there is an additional choice to be made—regular or limited pay.
Regular pay is when the term of the policy and that of premium payment remain the same. It is limited pay when insurers allow you to limit the number of premiums to five, seven, 10 or 15 years when the policy term is longer, say, 30 or 40 years.
But is limited pay really better than regular premium payment? Most online insurance distribution platforms and insurance companies promote the limited payment option. For example, a term insurance policy of ₹1 crore coverage and a policy term of 30 years for a 30-year-old person envisages a premium of ₹11,138 under the regular payment mode, going by a leading insurance company’s website. If you opt for a limited payment option of 10 years, the premium will increase to ₹23,550.
If you were to calculate the total premium outgo in both options, this comes to ₹334,140 (the premium amount of ₹11,138 multiplied by the term of 30 years) in the regular mode and ₹233,500 ( ₹23,550 multiplied by 10 years) in the limited mode. Here, you find that the premium outgo in the limited option is 43% cheaper than that in the regular option. Sales executives of insurance companies will highlight this difference and most people thus tend to opt for the limited mode. However, here is the catch, and insurers will never tell you this. Understanding the concept of ‘time value of money’ is necessary to figure this out.
Time value of money
The value of a rupee today is worth more than what it would be in the future. This happens due to inflation which reduces the purchasing power of a rupee, and this is known as the time value of money. What you can buy with ₹100 today will not be the same in future. It means that if you pay upfront money for something that can be paid over time, you are in fact paying more now, say financial experts.
Abhishek Kumar, a registered investment adviser and founder of Sahaj Money, a financial planning firm, calculated the insurance premiums under regular and limited pay in accordance with the time value of money to bring out this reality. (see graphic)
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As per this calculation, the value of the ₹11,138 annual premium will reduce to ₹10,508 in the second year and ₹9,913 in the third year, factoring in inflation at 6%. The actual premium outgo in that case in 30 years will come in at ₹1.62 lakh. In case of limited pay, ₹23,350 will become ₹22,028 in the second year and ₹20,781 in the third year. The total premium outgo in 10 years will come in at ₹1.82 lakh. This is 11% higher than what the total premium outgo is in the regular pay. It means in real terms, the regular payment option is 11% cheaper than the limited option.
“Paying insurance premium for a lesser number of years might look cheaper in absolute terms but, when adjusted for inflation, the net present value of total premium paid over 30 years would be less than what one would pay for 5, 7 or 10 years. This is because a single rupee in future would be worth less than the value of the rupee today, adjusted for inflation. Customers tend to only compare the absolute value,” says Kumar.
There is another reason why a regular pay option is more suitable than the limited one. When a person buys a life insurance policy, the intention is to protect the family’s financial goals. However, the policy becomes ineffective if you manage to secure all your financial goals during the policy period and nobody is dependent on your income. It is quite possible that by the time a 30-year-old policyholder turns 50 or 55, his children will start earning and there will be adequate pension for his spouse.
“If important goals such as children’s education and marriage have been achieved already with investments and savings, there is no point in continuing the term plan. In a regular option, you can stop paying premium to save on future premiums, but in the limited option, you have already paid the premiums for the entire policy term,” says Kumar.
To be sure, the policy period in single premium payment policies is usually 20 years. The single premium for a 30-year-old buying a term cover of ₹2 crore will be around ₹2.92 lakh. In a regular option, the premium will just be ₹14,579 per annum for 20 years. In real terms, the regular option will be 39% cheaper than the single premium payment mode.
“Some people opt for single premium payment mode to avail of the maximum exemption provided under Section 80C of the income tax Act, but there are better ways to do so. Upfront payment of premium to insurers is not a good idea,” highlights Kumar.