Why we are averse to term insurance :: Business Line

Are you comfortable buying term insurance? If your answer is yes, then you are not the typical customer for the insurance companies. In fact, one reason why insurance companies have so many products today is because most of you do not like buying term insurance.

While it is true that we like to shop, but spending is not something that comes naturally to most of us. This is because a part of our brain called the insula prompts us to avoid purchases, as we will experience pain when we part with our money. So, you normally buy a product only if you believe that the benefit from the purchase is greater than the pain you suffer when you pay for it.

Now, take term insurance. It requires paying a periodic premium for a pure risk cover. That is, should the person die during the policy cover period (which is typically 80 years), the beneficiary named in the contract gets the insured sum. If, however, the individual survives beyond 80, the insurance does not pay any survival benefit.

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This product obviously does not excite the brain. Why? There is no certainty that the beneficiary will receive the cash flow during the policy period! The pain from buying the product is, hence, much more than the perceived benefit.

That is, perhaps, one reason why insurance companies offer a survival benefit with term insurance. The survival benefit is an investment product wrapped around the term insurance contract. That fetches the insurance company good revenue; it makes your brain happy as well! Why? The beneficiary receives the insured sum if the person dies. And there are cash flows even if the person survives. This makes the product attractive and in fact makes it appear that the insurance company is offering an investment product with free insurance.

But what makes the brain happy does not have to make economic sense. If you do the math, you will realise that for the same cash outflow, you can buy term insurance from an insurance company and invest in mutual funds separately. And importantly, generate higher returns.

The trick then is to cheat your brain to accept term insurance. Or hope that the Government frames a regulation, forcing individuals to buy term insurance. Just like there is one for motor vehicle insurance. You will then not suffer the pain because the decision to buy term insurance would be forced on you.