- Date : 16/03/2017
- Read: 5 mins
The primary purpose of life insurance is to provide protection to one's financial dependants.
By Sunil Dhawan
There are, however, savings-oriented life insurance plans which in addition to providing protection help one save for long-term goals. Such plans could be participatory (with-bonus) or non-participatory (without-bonus) in nature.
The non-participatory plans, instead of declaring bonus which may vary depending on the profits that insurers make, may carry a guaranteed return/addition in lieu of bonus. The element of guaranteed return in the form of guaranteed additions (GA) in life insurance plans makes them attractive for those who want fixed and assured return on their savings. Let's explore them and see if they are worth buying.
The favourite sales pitch for such guarantee plans is that they offer 8-9 percent return on premium or even 100 percent return in some cases! Sample these - "Guaranteed addition of 7-9 percent of premium per annum" or - "Guaranteed payouts of 126 - 138 percent of annual premium each year". Who would not fall for such returns, which are also fixed and are assured for a long term?
But, hidden beneath the complex wordings of insurance plans is the payout structure. The terms and conditions of the payout are so convoluted that comprehending it may not be an easy task for many.
Buyers have to first understand that guaranteed addition is not equivalent to guaranteed return. These guaranteed benefits accrue only on maturity and hence the actual return will not be what is perceived or told to the customer. Any guarantee always comes at a cost. Therefore, the returns after adjusting for the costs because of the guarantee are low in such plans.
Although actual returns would depend on one's age, term and the premium amount, the average IRR (internal rate of return) in most traditional plans, including money-back and endowment, lies between 4 and 6 percent per annum. The plans with guarantee would carry even lower returns. "Compare the IRR (internal rate of return) of 2-3 selected plans and also consider the payout structure to suit your need", says Anil Rego, CEO & Founder, Right Horizons.
Varieties in guarantees
The structure of the guaranteed plans is not the same across insurers. Some may offer a guaranteed return based on the premium while others may offer returns on the sum assured. The guarantee may also differ based on the term of the policy or even the premium-paying term. Also, in case of some plans, guaranteed returns get added to the policy from the second year onwards while in some cases, returns may start at a later date.
Need-based payout structure
Since the structure of payout is not the same while returns are almost similar, choosing the right plan will depend primarily on the way the payouts are structured. And that would depend on how the plan is structured. Some of these plans are similar to money-back plans wherein there is a regular flow of income at regular intervals, while in some cases, there could be a lump sum payment on the plan's maturity. In case of some plans, payouts are made for a certain number of years after their maturity.
The death benefit, however, is more or less the same across all such plans and is higher of the sum assured on maturity or 11 times the premium or 105 percent of the premiums paid.
Therefore, one needs to go for guaranteed plans if fixed and assured returns are preferred over low returns. "The payout structures, especially in money-back schemes, can be used to ensure cash flows at important future goalposts, such as higher education of a child, or payment for a home. It is always advisable to speak to a financial advisor who can help to best fit the plans as per the needs of an individual", says Rego.
Let's see how a typical GA plan works. Assume there's a guaranteed plan for a term of 10 years but with a premium paying-term of 8 years. The plan offers guaranteed payout of 150 percent of premium every year after maturity for 8 years.
It means premium is to be paid for 8 years but life cover will be provided for 10 years. After maturity, payouts will be made for the next 8 years. Illustratively, if the premium is Rs 20,000, it has to be paid for the initial 8 years. Thereafter from 10th till 17th year, there will be an annual payout of Rs 30,000. Therefore, such a plan could suit someone looking for a regular income after 10 years.
Similarly, there could be a guaranteed plan in which every 5th year, 125 percent of the premium is paid out while the GA is added to the policy each year, to be had on maturity along with SA (less amount paid every fifth year). In some other guarantee plans, the payout could be entirely on maturity, including GA and the sum assured.
Being traditional plans, these are inflexible in nature. The term once chosen can't be changed. For someone who has started saving for, say, 20 years, might need to access one's savings in the 16th or 19th year. Surrendering the plan then would be costly. Most such plans also do not allow partial withdrawals. Even the sum assured cannot be changed.
Related: How to customize your life insurance policy with riders
As an alternative, one may buy a pure term insurance plan and simultaneously save through long-term bank deposits or recurring deposits as the returns are fixed there. Remember, returns from bank deposits are taxable as per the investor's income slab, while proceeds from life insurance plans are tax-exempt. Rego says, "The right plan would be a combination of term insurance and traditional policies, depending upon the taxation and cash surplus with an individual."
Life insurance plans with guaranteed additions are relatively costly. They suit conservative investors who do not want any volatility in returns and want a certain fixed amount on maturity. Conservative investors who are willing to accept a little uncertainty in the maturity amount may stick to non-guaranteed (bonus-based) traditional life insurance plans.
Source: Economic Times