Term insurance is a risk management tool. Before we address risk management tool in detail, let me give you an example of risk management. After explaining risk management, I will further explain what term insurance is, and then ‘what’ and ‘why’ of purchasing a term insurance is.

I assume that most of you reading this article must be having a car or bike to travel to workplace or for day-to-day commutation. Let me ask you, what is the first action you take when you purchase a car or bike (other than registering your car, paying road tax, driving licence etc.)?

The answer is that, you purchase an insurance policy. And why do you purchase an insurance policy for your car or bike? First, it is to cover for any damages in case of an accident. Second, because it is compulsory i.e., compulsion regulated by the government (only third-party insurance is compulsory).

What do you get in return? You get peace of mind because of three reasons –

  1. The expenses of repairing the vehicle are covered by the insurance company in case of any damage caused by an accident.
  2. Any third-party damage caused by your vehicle is covered by the insurance company.
  3. You do not have to run away when you see a policeman on the road checking documents. (Trust me, few of the vehicle owners purchase vehicle insurance only because of this reason 😊)

What will happen if you do not purchase a vehicle insurance policy? You will have the risk of paying damages from your own pocket if you run into an accident.

So, what are you basically doing when you are purchasing a vehicle insurance policy? The answer is, you are simply transferring the risk from yourself to the insurance company. The entire expenses would be paid by the insurance company in case of damages caused by the accident (though 100% claim is not paid by insurance company, this is just an example). You can call it risk transfer or risk management, but it for sure ensures peace of mind in case of any unfortunate event.

Now that you have understood the basic concept of risk management, let us see how this risk management tool works in our life.

What is Term Insurance?

Term Insurance is a risk management tool to cover the financial loss i.e., to cover your family’s financial needs if you are not around.

No one can replace the emotional loss of a family if any member of the family dies. It would be more difficult if it is the earning member of the family. But the family still need to survive financially.

If you have substantial assets (like FDs, mutual funds, real estate, bank balance etc), it would ease the family’s financial burden. But what if there are no financial assets. How do the family manage the same lifestyle? How do they manage to achieve the financial goals?

This is where Term Insurance comes into picture as a risk management tool i.e. to provide financial security to your family in your absence.

How does term insurance work?

The concept is very simple. You apply to purchase a life insurance policy called term insurance for a particular sum assured and a particular term. The annual premium is decided by the insurance company based on your age, sum assured, health conditions, habits, job etc. You pay the premium for the term of the policy. If you die in between, the insurance company will pay sum assured to your family. If you survive for the term of policy, you will not get anything back.

Insurance companies have invented different variants where premium is returned after policy term is over, which will be discussed in another article.

Before I give you an example of how Term Insurance works, let me define the basic terms;

Sum assured – Sum assured is the amount of money that the insurance company promises to pay to your family in case you die.

Premium – Premium is the amount of money; you promise to pay to insurance company for term insurance cover which is basically, the sum assured.

Term of policy – Term of policy is the time frame for which you promise to pay premium to the insurance company or insurance company promise to pay the sum assured. The term can be 5/10/15/20 or 40 years.

Still confused? Let me give you an example.

Ajay is 27 years old and decides to purchase a Term Insurance cover of 1 Crore. He applies to different insurance companies and gets the premium quote of 10,000 per year for sum assured of 1 Crore. Finally, he decides to purchase the term insurance cover from ABC Company for a term of 33 years which is, till his age is 60. The premium amount comes as 10,000 per year.

If between the age of 27 to 60, Ajay dies, the insurance company will pay the amount of 1 Crore to Ajay’s family. If Ajay survives beyond age 60, the insurance company will not pay anything and Ajay will not get his premium back. It is as simple as that.

This is what Term Insurance is.

Now, why Term Insurance?

Ajay is working in a multinational company and is earning well. He is the single earning member of the family. He is also very smart in investing his money. He is 27 years old, his spouse is 26 years old and they have a lovely son who is aged 2 years. Ajay’s parents are dependent on him. He has already started investing for his son’s higher education/marriage goal, retirement planning, home purchase and various other goals.

But one thing he never believed in was to purchase a term insurance cover. His term insurance cover requirement was around 2 Crores and the premium was around 20,000 per annum. Why to waste money on term insurance cover if I am not going to get anything back if I survive was his way of thinking. Would it not be better if I invest the same amount of money and get handsome returns?

Fast forward a year, Ajay met with an accident and died unfortunately (Sorry for being so blunt about using the word die everywhere, but I must be blunt here). He had an investment amount of around 30 Lakhs. Now, would this 30 Lakhs be enough for his family to survive?

The answer is No.

If the answer is no, what can be the possible scenarios for his family?

  1. Would his family be able to maintain the same lifestyle?
  2. Would his parents have to start working at old age?
  3. Would his son’s goals be achieved?
  4. Would they be able to purchase their dream house?

There can be thousand of questions here and the answer is none but, one- term insurance.

Again, no one can fill the emotional gap, but someone must fill in the financial gap and that is the reason why term insurance is here for us.

Points to remember

If you have enough assets, there is no need to purchase term insurance but if you don’t have any, purchase Term Insurance cover. The goals need to be fulfilled even if you are not around.