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Splitting your insurance policy

November 18, 2003 11:23 IST

The home loan cover, or the term assurance policy, allows insurance-seekers to take insurance at a very low premium.

More importantly, it allows one to cover the outstanding liability on a home loan.

We take a look at one of its most important features that allow clients to split the policy so as to reduce the premium component significantly.

In the term assurance policy the individual is covered only for life risk, i.e. there is no saving element. That is why this policy is also referred to as pure risk cover.

The individual's premium is calculated as per his age and tenure as in an endowment.

But unlike an endowment plan where premiums are high, term assurance plans have very low premium since they cover risk to life only and do not have a savings component.

In other words, if the individual were to survive the term plan tenure, he will receive nothing, not even the premia that he has paid.

He has the option to go in for a return of premiums plan if he would like to get the premiums back at the end of the term. However, we do not believe that is such a smart thing to do.

Term assurance plans are particularly advisable to those who have taken home loans and wish to cover it against any eventuality.

Home loans are a 5-30 year liability. Should anything happen to the breadwinner in this period; his dependents could potentially become homeless after his demise. It makes sense for the breadwinner to provide for such an eventuality by covering this risk.

Since the plain vanilla term assurance plan do not provide for return of premium, the insurance-seeker must try to minimise his premium outflow to the best possible extent. One way to do this is to split the policy.

We have shown how this can be done by way of a simple illustration.

In our illustration we have the instance of a healthy 45-year-old male. Sum assured - Rs 10,00,000. Tenure - 15 years.

Illustration (A)
Sum Assured (Rs) 1,000,000
Tenure (yrs)15
Annual Basic Premium (Rs)6,460
Total Outflow for 15 years (Rs)96,900

As reflected in Illustration (A), the individual pays a total premium of Rs 96,900 over 15 years for a pure risk cover of Rs 1,000,000.

In Illustration (B), the individual splits the policy into 3 with varying tenures and sum assured which have been mentioned in the table.

Note that with the increase in tenure, the sum assured decreases. This is because with the passage of time as the monthly loan installments on the home loan are paid, the outstanding loan amount decreases. So a person, needs to reduce his term cover by that extent.

Illustration (B)
Sum Assured (Rs) 500,000300,000250,000
Tenure (yrs)51015
Annual Basic Premium (Rs)2,5751,7611,728
Total Outflow for 15 years (Rs)12,87517,61025,920

In Illustration (B) with differing tenures and sum assured, the individual's premium outflow amounts to only Rs 56,405.

Compare this to his premium outflow of Rs 96,900 in Illustration (A).

There is a significant savings to the tune of Rs 40,495 in Illustration (B), which amounts to savings exceeding 70% of his premium outflow.

By splitting the policy, an individual can reduce his premiums significantly. He only needs to match his home loan liability with the sum assured and choose the tenure accordingly.

This little bit of planning and arithmetic could save him a lot of money.

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