This article first appeared on fundMyLife, the platform that connects financial planning questions to the right advisers.
Premiums are no stranger to a policyholder when one has to part with his money to get insured. However, the topic of premium payment usually surfaces only when you have sat through a long policy explanation by your financial adviser so by the time you have to select your premium payment method, you would probably just agree with your adviser’s suggestions, trusting that it would be the ideal choice for you. Well, that is true most of the time, but paying premium is not as simple as forking out money every month and here are things you need to know before agreeing to that monthly premium payment!
For those who are unfamiliar with the term, an insurance premium is the amount of money an individual or corporation has to pay for purchasing an insurance policy. In short, the cost of your insurance. For the insurers, it represents a liability that they must provide coverage for any claims made under the policy.
Mode Of Premium Payment
The mode of premium payment determines the frequency and method of payment that the policyholder needs to pay to the insurer for the insurance plan.
Single vs Regular Premiums
Although the choice of single or regular premium payment may not be applicable for all policies, it is good to understand what each payment entails.
Single premium requires one to make an upfront payment – that is, pay the entire premium for the policy in one shot. This may be too overwhelming for some as they have to fork out such a large sum of money at one go. Most people are unable to afford such a hefty sum, especially when a longer policy term means more premium required in total.
On the other hand, as the name suggests, a regular premium would require payment at regular intervals be it annually, bi-annually, quarterly, or monthly. For regular premiums, you must be able to keep up with the payments over the long term. Otherwise, the policy may lapse and the policyholder may be at a disadvantage without the desired coverage at critical times. Hence it is always essential to ensure that you are able to upkeep the premium amount throughout the policy term.
Premium Payment Period (May be dependent on policy terms)
Premium-paying term is the total number of years the policyholder is required to pay the premium. Usually, the premium-paying term would be the same as the policy term. However, some policies grant the policyholder some flexibility in premium-paying term. A shorter term would allow you to complete your premium payments earlier while a longer term enables you to fork out a smaller amount for each payment. Regardless of the term chosen, you will still enjoy the coverage for the entire policy term. However, a shorter premium-paying term means that the policy would be able to accumulate more cash value and hence give a higher surrender value.
Frequency of Payment
The most common dilemma would be the frequency of premium payments. Does it matter if you pay annually, bi-annually, quarterly or even monthly? Yes, it does! As a general rule of thumb, a higher frequency payment entails a smaller denomination per payment BUT higher total cost. Paying annual premium helps to cut down on policy costs as annual payments have better rates than monthly payments. You can actually save up to 7-9% in total costs when you pay annually instead of monthly!
The rationale behind the cost difference is the uncertainty in cashflow for the insurers when payments are made in intervals as compared to a lump sum payment. The higher cost also includes the additional collection cost required to process frequent payments.
Choosing The Frequency Of Premium Payment
While the argument for annual payment is appealing, there are other factors of consideration you should think about before making your choice. Here are some of the factors that you should consider.
# 1 Cashflow And Liquidity
If you are a student or fresh graduate trying to get by with your monthly income or starting salary, a large lump-sum payment would limit your cashflow significantly. Also you never know when you might need some additional cash after you have made your annual payment!
# 2 Opportunity Cost
If you can find a way to grow your money such that the returns are greater than the extra costs of monthly payment, maybe it would be wiser to go ahead and invest your money instead.
# 3 Refund After Termination
Most insurers would not refund your paid premiums so you might run the risk of losing your paid premiums after making annual payments (or even single premium) if you terminate your policy later on. As such, it is important that you are 100% sure that you need this policy before committing to an annual payment.
Other Things You Should Know About
# 1 Level Premium vs Flexible Premium
Whether the premium is level or flexible is usually embedded in the policy so it would not be dependent on the policyholder.
Stepped premiums mean that your premiums increases each year as you get older. Stepped premiums are usually cheaper at the beginning but the increasing costs may mean that level premiums are likely to be cheaper in the long run. These are more suitable for those who intend to get a new plan as they age or those who are financially tight in the short term and prefer more economical premiums at the beginning of a policy.
Level premiums stay the same throughout the policy term. It is generally more expensive than a stepped premium in the beginning and may have slight increases due to inflation adjustments. Level premiums are more suitable for those who would want a greater control of costs over time and those who would have the same life insurance for a long time.
# 2 Failure To Pay Premium
What happens if you are unable to pay your premiums on time?
Grace Period: If you fail to pay your premiums, insurance companies typically have a one-month grace period with no interest charged.
Automatic Premium Loan (APL)/ Non-Forfeiture Loan (NFL): However if you exceed the grace period, the insurer will automatically take a loan against the policy’s cash value (if the policy has sufficient cash value) to pay for the overdue premium. While this keeps the policy in force, interest would have to paid on this loan.
If the NFL together with accumulated interest is more than the cash value of the policy, the insurance company terminates the policy.
Premium Holiday: As its name suggests, a premium holiday is when you take a break from paying your premium for a certain period of time (for as long as the policy has sufficient cash value to keep it in force).
Paid-Up Value / Reduced Sum Assured: A policy with sufficient cash value may be converted into a paid-up policy whereby you need not pay any more premiums and your policy would still be in force for a reduced sum assured for the rest of the policy term.
Reinstating Your Policy: After your policy lapses, you may choose to reinstate it within a given period, as long as certain conditions (as stipulated by the insurer) are met.