Various category of Life Insurance Policies in India:
Many times you might have thought “How can insurance company pay claim amounts as big as 1 crore in consideration of premium as little as Rs 6000 per annum?” It is possible because the insurance company creates a big pool of funds via a collection of nominal premiums from individuals who face a similar risk. When one of the contributors faces loss upon happening of contingency i.e. death, then insurance company takes out the sum insured of the policyholder from that pool & compensates his family members. Life Insurance, thus, provides for financial security of the survivors upon unfortunate death of the earning member of the family. A question must have risen in your mind now “What is the need for such an arrangement if you can manage everything on your own?”
Let me tell you a story. Once upon a time, there lived 1000 families in a village. One day upon the death of the earning member of a family, the financial independence of that family went into jeopardy. The deceased breadwinner did not leave much savings. Looking at the plight of the family, other families in the village decided that each family would contribute a certain amount & create a fund. This fund would be given to the family of the deceased person. The families realised that the contingency i.e. death of breadwinner is certain; only the time is unpredictable. When all of them were involved in the creation of fund then the burden on each family to save money reduced considerably.
It’s incidents like the above that paved way to the evolution of life insurance. Thus, the primary objective of life insurance is to provide financial security to the dependents in case you are not around.
But a significant majority of people buy insurance with an investment objective. The foundation of such faulty perception in people is laid by the insurance companies using their marketing gimmicks. “Insurance is a solicited product” is a quote which is better said than done. The desire for life insurance product is created in individuals by the insurance agents who primarily use the “Investment Appeal” to push the life insurance policy.
To avoid the bandwagon effect, read on to check out different types of life insurance policies available in India & various points that should be kept in mind while buying one.
Types of Life Insurance Policies
1. Whole Life Insurance
These policies provide you risk cover for entire lifetime extending even up to 100 years of age. You may go for limited premium payment term or regular premium payment for the entire tenure of the policy. There is a guaranteed sum assured which would be given as death benefit to your nominees. In addition to that, there are bonuses declared by the insurer which keeps on adding to the basic sum assured which leads to a gradual increase in the life cover. Some insurers provide an option to offset future premiums or to purchase extra sum assured from the guaranteed bonuses so declared. As maturity benefit, you get Guaranteed Maturity Sum Assured + accumulated Bonus + Terminal Bonus. Various riders like additional risk coverage, accidental death benefit & waiver of premium can be purchased with the basic policy to get comprehensive risk cover. Partial withdrawal of accumulated bonuses & loan against the policy is available in most whole life policies. Overall, these policies typically give a meagre 4-5% as a return on your investment, which is quite ineffective to tackle inflation.
2. Endowment Plan
Endowment plans emphasise on their systematic & disciplined saving mechanism which would provide you with a big corpus on maturity. Unlike whole life policies, the policy term ranges between 5-30 years. These provide both death benefit and maturity benefits. There is a guaranteed sum assured along with bonuses which would be given in lump sum as the death benefit to your nominees. The death benefit is generally the highest of; 10 times the annualised premium, Guaranteed Sum Assured on Maturity or 105% of all premiums paid. The maturity benefit consists of Guaranteed Maturity Sum Assured + accumulated bonus that you will get at the expiry of tenure. You can buy the plan with a single premium, or you can choose to pay the premium at regular intervals. By inclusion of riders like accidental death and disability benefit, term assurance; you can go for comprehensive risk coverage. Endowment plans charge a higher premium as compared to term insurance. Facility of loan against the policy is available in these policies.
Let me explain with the help of an example about actual worth of endowment policies:
Name of Plan= SBI Life Shubh Nivesh
Age at entry= 26 years
Annual Premium Outgo=Rs. 31000
Policy term=15 years
Premium payment term= 15 years
Death Benefit=Rs. 500000 + Accrued Bonus
Maturity Benefit=Rs. 6,63,875
Following table illustrates calculation of returns for an Endowment policy:
The rate of return earned in the above example is just 5% which makes endowment policy a poor choice for making investments. These policies usually give you a return of around 4-6% on your investments.
Also read:Term Insurance vs. Endowment
3. Money Back Plan
As the name suggests, the plan pays you back a fixed percentage of the basic sum assured say 15-20% called Survival Benefits at certain policy milestones say 5th, 10th, 15th year during a policy term of 15 years. Your nominee gets 105% of sum assured along with bonuses (if any) as death benefits. If you survive the policy term, then you get a reduced sum assured (Basic Sum Assured-Survival Benefit) along with bonuses (if any). You may find a combination of 3 components i.e. saving, regular income and protection under a single policy. Moreover, these policies assert that periodic payouts would help you to pay-off major expenses at critical stages in life. But you should keep in mind that the timing of periodic paybacks need not coincide with your life goals. So, these plans may have been suitable for others but may prove inappropriate for you. Besides, the IRR at 4-6% makes this policy highly inappropriate investment option owing to the prevailing inflation rate.
Once upon a time ULIPs were star investment products when these were launched for the first time in India. The markets were bullish & investors churned out huge profits from their investments. But subsequently, as the markets went southwards, the investors lost a fortune. ULIPs became really notorious on account of misselling by agents who made the product look a pretty good investment-insurance combo. Ultimately in 2005, the IRDA improved the structure of ULIPs by streamlining the charges to revive it as a hopeful product.
The structure of Unit Linked Insurance Plans (ULIPs) involve deducting Premium Allocation Charges & Sum Assured of your choice & assigning the remaining premium amount to a fund which invests in equity, debt or combination of both (as per your indicated preferences). On the invested amount, Mortality Charges and Administration Charges are levied periodically by cancellation of units. Moreover, your Net Asset Value gets reduced by the Fund Management Charges on a daily basis. The Maturity Benefit you get is called as the Fund Value which rises & falls depending on the performance of the fund opted by you.
For example: Consider your annual premium to be Rs 40,000 & after deduction of Premium Allocation Charges of Rs 2000, the amount going into investment in equity fund is Rs 38,000. Suppose if the Net Asset Value of the fund is Rs 20, then 1900 units would be purchased out of Rs 38,000.
If you are a risk-seeker, then Mutual Funds would be a better investment option than ULIPs owing to certain limitations present in ULIPs. The choices of fund & asset classes are restrictive in ULIPs. The ULIPs offer lesser flexibility than Mutual Funds due to high initial investment amount & greater lock-in period. Moreover, the entire structure of charges is complex enough to leave you apprehensive about your investment returns. My advice for you would be to go for a combination of term insurance plan & mutual funds which will give you better risk protection & higher real rate of return. Investment in Mutual Funds can be started with SIPs of as less as Rs 500 per month. Moreover, if you consider the historical data of past ten years, then you will realise that MFs have given higher returns as compared to high performing ULIPs.
5. Term Insurance Plans
If you consider the case of villagers in the above story, then you will find that insurance originated in the form of term insurance.
Term Insurance is based on the concept of replacement of income earned by the breadwinner upon his death. The basic thumb rule says that you should buy risk cover i.e. 10-12 times your annual income. Term Insurance is based on the same fundamental. Term Insurance provides a substantial risk cover in consideration for a nominal annual premium. Term insurance doesn’t have an investment component & these are pure protection plans. These policies ensure that your dependants continue with the same living standards when you are no more around them. Only death benefit is available under these policies, and there are no maturity or survival benefits. You can select to pay a single premium or a regular premium. Since the premium is charged only for life cover, you may get high coverage of up to Rs. 25 Lakh at a monthly premium of as low as Rs. 1200. There is no surrender value, and the policy does not attain paid-up status. When you choose Accidental Death Benefit rider, your family gets additional sum assured over and above the basic death benefit. Term Insurance is the order of the day & you should get one for yourself as soon as possible.
Term Insurance has always been regarded as better insurance product than any of the above life insurance categories since there is no investment angle in this & it comprehensively aids you in managing your financial risks.
The fundamental purpose of buying any insurance product should be to manage your financial risk. If you perceive insurance as an investment product, then you would neither get adequate risk protection nor the real rate of return. So my advice is to buy a combination of Term plan and Fixed-Income product like PPF, instead of an endowment/money back, on the other hand, choose a mix of mutual fund plus a term plan if you are looking to buy a Ulip.