Term Life Insurance Vs Inflation

POSTED BY Kirubakaran ON December 24, 2010 11:02 am COMMENTS (6)

Hi,

 I am kirubakaran, 23 years of old. I wanted to take the term life insurance premium of about 50 lakh.

 After 30 years, considering the fact of 6% inflation, it would be just 8.75 lakh (comparison) value. Is it intelligent?

 The calculation shows ,I have to take a premium of about 2.8 crore to get the value of 50 lakh after 30 years…

 Am I missing something?

Please share your views.

6 replies on this article “Term Life Insurance Vs Inflation”

  1. shashank kashettiwar says:

    It is not at all a very complex exercise to attempt caculations to understand the effect of insurance-whether positive or negative- on the wealth being created by an individual.

    Three things are required:
    1. The savings % in the income
    2. The rate of growth or return on these investments and’
    3. The rate at which the income itself is growing(understanding this ‘human capital’ growth rate is a bit tricky affair!)

    This wealth accumulation can be plotted at different ages, where various goals of life are to be fulfilled and also at the retirement stage.

    We can calculate the insurance effect on the wealth with two extreme scenarios-
    1. ‘Zero’ insurance and what effect it can have,
    2. Full insurance considering insurance to be a ‘notional asset’ which is required to protect the economic value of a ‘human capital'( what is full insurance?)
    3. Also in between scenarios as suggested by the proponents of insurance as an ‘expense’ can also be analysed.

    I promise you if you do this exercise , all your perceptions of looking at insurance would shift dramatically. It could be extremely uncomfortable situation for many individuals because they have formed some opinions over a period of time and it is not easy to find those to be all wrong.

    Retirement stage is the vantage point. If you can place yourself properly there, you get a bird’s eye view of the life behind and the life ahead. Till this moment we were working for money, now the money needs to work for us. What is wealth, what is money, what is an asset , what happens to the wealth created -all these questions and answers to them seem to have a new meaning from this vantage point .

    Prabeesh, you attempt this. Whatever wisdom I may have regarding financial planning has been gained from this exercise. Just see what new perceptions and clarity you can develop.

    shashank

  2. bharat shah says:

    as such the insurance is expense , and so it should be optimum as neccessary. the argument that as you grow, your income would grow, your life style would improve, so insurance requirement would increase, is not correct. actually the income would stop one day, i.e.on retirement. also for earning savvy investor , the corpous would increase with time.so it is prudent to have well thought term insurance policy, and balance of saving should go to pure investment, may be equity, debt. commodities, realty as per one’s choice, but in no case other forms of insurance.

  3. prabeesh says:

    @shashank

    Reading your comments have given me more perception than one towards any product.

    My question in this thread is what are the problems, if i choose to have a narrow view?.

    say for example…i arrive at 50L as my insurance amount for 30 years and i will also invest some money in side by to grow the wealth for my family.which in case if i die anytime, along with insurance amount will make my family achieve all financial needs.

    I assume there is substantial improvement in my income and life style(spending) for every 5-7 years . At same time it will also increase the investment money that i am committing too.

    Then in this case why should i keep buying more insurance cover,i fail to understand the reason.Please point out those that i am missing to include(which i am sure there are many)

  4. Gaurav says:

    The insurance amount is to cover the needs of today. As you grow, and start building wealth, your liabilities will probably grow too (kid 1, kid 2, home loan etc.). You can always opt to go in for another term policy for the additional amount you think you need.

    1. shashank kashettiwar says:

      If you look at insurance as a tool to secure only some aims of life then this view is correct that your insurance need would (probably?) go on reducing as you keep on building a corpus as you keep on living and working. But this is pretty narrow view of looking at it.
      The broder view is to protect the whole of your income or look at the income as the starting point and not the aims as such. (The aims are a subset of the income and wealth created.)

      So if we look at ourselves as an asset whose earning capacity i.e. worth goes on increasing and ceases only at our retirement then it is logical to keep on increasing our insurance cover to protect this appreciating money stream. So now insurance takes on the form of a ‘notional asset’ which is protecting the economic value of the ‘human asset’.

      Now this protection asset should keep on increasing its value with inflation and also with the increase in the earning capacity if any. Usually the earning capacity of the ‘human capital’ grows at a faster pace than the inflation(otherwise every one would become poorer and poorer; not the case for the mass affluent class of the population- The Haves)

      So if you want the insurance asset to imitate the human asset or act as the counter balancing mechanism to protect its worth from the uncertainties of life, the insurance strategy to be adopted should keep on growing the cover. The typical level term plan doesn’t have this feature. The premium and the cover both would remain static. Hence the cover will have reduction in value because of inflation. (We all are so concerned about inflation eating away the other assets but not so in case of the insurance assets.)

      Increasing the ‘notional asset’ value when the premiums are also level can happen only if we choose savings type of plans in the insurance portfolio- Endowment or Whole Life type. The endowment plans would increase covers through bonuses, though at a lower rate than the inflation because the focuss is on growing cash value as well. The whole life plans would grow the covers at near inflation rates but the cash values would grow at a slower pace. They are great products in the traditional /debt space but not studied and evangelised at all.

      If savings products are not to be chosen yet the covers are to be increased through term plans only then we have to keep on buying new plans every time there is substantial increase in income levels- typically every 5-7 yrs interval or choose some plans which have these type of features.

      But generally so much negative noise is created against these type of savings plans(ULIP and traditional as well) for various reasons , myths and a narrow perspective of looking at the insurance that , there is no sensible and balanced advice/guidance available to a lay person.

      There is a discussion going on in the forum on some querries regarding utility of ULIPs. Hopefully this querry would also lead to a comprehensive discussion on the role of insurance mechanism and the various products’ role and importance in devising a proper insurance planning strategy for an individual.

      shashank

  5. Kirubakaran

    This is a very good question 🙂 . I will try to answer this .

    1. The first point is there are some companies which give you Increasing term plans like SBI life shield and Aegon religare term plan . So if you want your sum assured to be increased every year by some percentage ,then you can opt for them .

    2. The other main point which you are missing here is the need of Insurance .

    We take insurance to cover the future money which we will be bringing in our life , so today you are taking a term plan for 50 lacs , but from now onwards you are going to start earning and saving , so side by side you will also be building some assets and have wealth . Which means that every year your insurance needs should actually come down which will be compensated by the wealth you will make in these years .

    So if you die when you are 45 yrs old , definatly the 50 lacs you recieve will be just worth 15 lacs but you will also have enough wealth by that time !

    Manish

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