Ever heard of the term HLV? Well, it stands for Human Life Value and is often one of the most important factors taken into consideration when calculating the ideal cover amount of a term insurance policy. You see, term insurance policies are supposed to act as your income replacement in the case of your unfortunate absence and offer financial aid to your family that would help them achieve their life-stage goals.
So, when you calculate the cover amount, a lot has to be considered - policyholder’s age, HLV, income slab, number & age of dependents, current financial liabilities, existing financial bandwidth, and more.
However, when dealing with potential policyholders, our advisors have often encountered a common question: " My kids will grow up and start earning in a few years & my income capability will decrease too, so do I still need this high cover amount through the entire term insurance policy tenure?”
This brings us to the topic of decreasing cover options in a term insurance policy. While the term is self-explanatory, there are a lot of factors that you need to be aware of if you have a similar doubt regarding the cover amount for your term insurance plan - what it is, how it works, the pros and cons, and accordingly, if you should at all avail of this decreasing option!
Read on and find out!
What is Decreasing Cover Option in Term Insurance Plans?
As the name suggests, a decreasing cover option in term insurance is a perk offered in some policies that allows the policyholder to enjoy the benefits (if any) of a mitigating sum assured over the years.
Since the financial goals of an individual undergo multiple changes across the years, there is a chance that you may need a lower cover amount than what was initially planned (with more financial liabilities on your plate).
Let’s take up an example to understand how this option functions.
How Does Decreasing Cover Option Work in a Term Insurance Policy?
(For this example, we are taking up one of the best term insurance policies in the industry - HDFC Life Click2Protect Super. The Decreasing Cover option in this policy is called the Life Goal perk.)
Amitava is a 38-year-old man with a 35-year-old spouse and a 15-year-old son. He has a term insurance policy with ₹2 crore coverage until he turns 60. However, he assumes that within these 22 years, his son will be 37 and financially independent, and, in case Amitava passes away, his son will take care of his mother.
Thus, he presumes that he wouldn’t need to keep on paying a relatively higher premium towards a ₹2 crore coverage. So, he opts for the decreasing cover option in his term insurance policy. Over the years, his base sum assured decreases by a certain % from the 5th policy year. Inevitably, this also means that he will be paying a lower premium towards the later years of his policy tenure.
So, basically, a decreasing cover option in term life insurance reduces your death benefit payout, thus offering you a mitigating premium.
Now, while it sounds like a lucrative perk considering the chances of reduced financial support requirements after your retirement years, the feature is not without its set of caveats. Take a look at the pros and cons of this feature and then decide if it’s worth the purchase!
Should You Opt for Decreasing Cover Options in Term Insurance Plan?
Decreasing cover feature in term insurance plans is a rare feature to find. Not all term insurers offer this, and once you go through the pros and cons of decreasing cover options in term insurance policies, you’ll know why -
- What are the Advantages of Decreasing Cover Options in Term Insurance Policies?
- Mitigated premiums: Since the base sum assured decreases over time (by a pre-decided % from a pre-decided policy year), insurers require a lower premium to be paid towards the policy.
ISSUE: The mitigated premiums may seem like a great financial saving, but term plans are usually pretty affordable in the first place. For example, a healthy 25-year-old male requiring a ₹1 crore coverage till he turns 65 needs to pay a nominal annual premium of ₹10k - ₹12k only. Opting for a reduced cover just because you want to avail yourself of even lower premiums doesn’t make much sense at all.
- Suitable if the term plan is just to cover debts - When you use a free tool to calculate your ideal term insurance cover amount, you need to provide information about your existing financial liabilities. For example, let’s say you have opted for a home loan that requires an EMI of ₹20k. This will count as your monthly expenses, and since a term insurance plan is crafted to act as your income replacement in the event of your unfortunate absence, the sum assured can kick in to cover your loan expenses.
However, if you have just availed the term insurance policy to ensure that no EMIs are missed in the event of your absence, here’s something that you need to consider - much like any financial debt plan, loans too come with a fixed policy period. Once the loan period ends and your EMIs are paid off, your monthly expenses decrease significantly. Thus, your financial requirements decrease. Such a situation might make you feel that decreasing coverage is a great feature to opt for.
ISSUE: Term insurance plans are crafted to act as an income replacement in the event of the policyholder’s death. These expenses don’t just include home loans or other debts. You have to factor in the future financial requirements of your dependents (children + spouse + parents).
- In case the term insurance policy is just to cater to small business funding - In the case of term insurance plans for business owners/entrepreneurs, the death benefit can often act as repayment funding to pay off the small debts availed. In such cases, a decreasing cover option in a term plan might offer just the nominal amount required to pay off these debts if the policyholder passes away.
ISSUE: When you purchase the best term insurance plans, you can’t just plan for your small business loans. If you want to tap into the complete potential of the term insurance plan and ensure that you get your penny’s worth, you might as well stay financially prepared for your family’s future financial requirements and life-stage goals. That means not opting for a mitigating cover amount for your term insurance plan.
2. What are the Disadvantages of Decreasing Cover Options in Term Insurance Plans?
When you opt for a term insurance policy, you are basically getting financial protection for your family in the event the main breadwinner of the family passes away. The idea is to make sure that your family stays on the path of achieving their life-stage goals without any financial hiccups.
Thus, when calculating the ideal term insurance policy cover amount, you need to enter the fields of - age of the policyholder, years till retirement, number of dependents, age of dependents, current financial obligations, and the existing financial bandwidth.
Suppose you have opted for a reputed insurance expert. In that case, they will also factor in the inflation rate to ensure that the base sum assured’s monetary evaluation stays significant years after you purchase the policy. Since term insurance plans are long-term financial commitments, such initiatives are essential.
Additionally, suppose you think of the best term insurance policies and the most credible term insurance providers. In that case, you will notice that they offer term insurance riders and features like increasing cover options and life stage benefits, which enable you to boost the policy cover amount over the years as and when required. This is in complete contradiction with the decreasing cover-term insurance policies.
Such increasing or consistent base sum assured makes sense if you consider that financial requirements only increase over the years. And even if you are not increasing the cover amount, letting it stay the same ensures that the death benefit at least meets the impending inflation spike.
Conclusion
One of the major reasons why decreasing coverage options in term insurance isn’t offered by a lot of term plans is that it’s not a lucrative perk. While term insurance plans are supposed to meet the evolving financial requirements of your family in the foreseeable future, decreasing the base sum assured will offer you very small reduction in premium and severely compromise your objective of staying financially prepared for any unplanned situations. Basically, the decreasing coverage option defies the purpose of your purchasing a term insurance policy. You should instead decide between buying a level-term insurance policy (sum assured stays constant) after considering the inflation rate or an increasing term insurance plan (cover amount increases by a certain % every pre-decided policy year).
