Why is the premium low for term insurance plans? Does the sum assured formula (yearly income multiplied by six) hold good for term insurance plans too?
Kritika Dhody, Chennai
The reason why premiums on term insurance are low compared to other forms of life insurance is because term plans are pure risk cover. Unlike other insurance policies, term plans do not mix savings and investments, which is why there is no maturity benefit in case of the most basic term plans. Maturity benefit is the amount policyholders receive in case they survive the policy tenure, whereas, in case of savings and investment type of policies—bonus too is paid out depending on the policy structure.
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Moreover, in case of insurance policies which combine insurance and investment, the premium received is broadly divided into three parts – cost of insurance, administrative charges and investment. In contrast, the term insurance deals only with the cost of insurance and administrative charges. As the agent’s commission on term products is low, overall administrative cost is also low. Because of this reason the premium on term policies is very low.
As for the sum assured formulae, such as income multiplier, they are employed as thumb rules to determine the amount of sum assured. There is no scientific basis for such equations. Insurance requirement differs from individual to individual and is based on a number of factors such as income, financial dependents, age and age of dependants.
