Nowadays when a life insurance agent comes to sell you a policy, the spiel is remarkably different. He no longer quotes the highs of the stock market or sells you the dream of quick money through equity investing. He instead assures the safety of your capital and guarantees your return. This change mirrors the changing trend in the life insurance sector, where traditional plans are making a comeback and leaving the once popular unit-linked insurance plans (Ulips) behind.
Owing to last year’s reforms and volatility in the stock markets, insurers have once again turned their focus on traditional plans. Unlike a Ulip where investments are market-linked and costs are transparent, traditional plans work on the principle of give and get— you pay x every year and you will get 15x+y in 15 years is how most traditional plans are structured. But over a period of 15 years, this 15x+y usually translates into a paltry return. Even the bonuses that most traditional plans offer are seldom able to improve the returns. So before you succumb to a traditional plan, here are four key questions you need to ask.
What you give and get?
This is an important parameter to consider.
Comparison: First, it enables comparison. Says Rituraj Bhattacharya, head (market management?), Bajaj Allianz Life Insurance Co. Ltd: “The way to compare traditional plans is to look at the guaranteed sum which is typically the sum assured. For this sum how much premium do you have to pay over a given term is how one can compare products.”
Costs: The give-and-get equation gives you a sense of the costs. Let’s understand through an example. Take a traditional endowment plan for a 30-year-old for a term of 20 years with a sum assured of Rs 10 lakh on an annual premium of Rs 46,931. The guaranteed payout under this plan is the sum assured and the non-guaranteed component is the bonuses which are at the discretion of the company. Compare this with a term plan which will charge an annual premium of around Rs 2,000 for the sum assured mentioned above over the same term. In other words, you pay Rs 44,931 extra to guarantee that sum assured on maturity.
Rate of return: The give-and-get equation of a traditional plan helps you understand the returns from the policy, too. Use a financial calculator that gives you the internal rate of return from the net or swing the numbers past your financial planner and you will understand the delusion guaranteed return is. In the above example, the return on your investment is just 0.66%.
What are the additional benefits?
But you also get bonuses, the agent will argue. Typically, in a traditional insurance plan there are three kinds of bonuses: cash, reversionary and terminal. The premiums that you pay get invested in a life fund which is kind of a perpetual fund that an insurance company has. Says Bhattacharya: “The insurer meets all his liabilities of paying claims or maturity through this fund. So depending upon the interest rate scenario and surpluses that this life fund has, a company may declare a bonus.”
Cash bonus: Once the company declares a bonus it becomes guaranteed. If you choose to have it as cash, it is called cash bonus.
Reversionary bonus: The guaranteed bonus can also get added to your sum assured. This is called the reversionary bonus.
But you must be careful with reversionary bonuses since they can significantly impact your returns. There are two kinds of reversionary bonuses: simple and compound. As the name suggests, a simple reversionary bonus is a percentage of the basic sum assured that once declared becomes a guaranteed payout, but a compound reversionary bonus is a percentage of the overall sum assured. Here’s an example: a 6% simple reversionary bonus on a sum assured of Rs 100 will bump up the sum assured to Rs 106 in the first year and Rs 112 in year two. However, a compound reversionary bonus will bump up the sum assured to Rs 106 in year one and Rs 112.36 in year two. But Kapil Mehta, managing director, SecureNow Insurance Broker Pvt. Ltd, has a word of caution: “The rate at which a simple reversionary bonus is paid out creates an optical illusion because the rates are more than the rate of a compound reversionary bonus. However, in the long term and with the power of compounding, a compound reversionary bonus tends to give you better returns.”
Terminal bonus: This is again totally at the discretion of the company and is paid at the end. Says V. Viswanand, director and head (products and persistency management), Max New York Life Insurance Co. Ltd: “One also needs to look at liquidity in a policy. A cash bonus is a good idea in that sense because it gives you the freedom to have the money at your disposal anytime you want.”
Bonus rates: You should also have an idea about the bonus rates that the company has been declaring. Most companies will have some historical data of their bonus rates, which can access through the insurer’s website or the agent.
Says Bhattacharya: “Typically, a company does not have a lot of volatility in bonus rates. Since the bonus rates depend on the surpluses in life fund, interest rate is only one factor that determines that surplus. Hence, most companies will maintain a stable bonus rate structure.”
Adds Kapil Mehta, CEO, SecureNow, an insurance broking firm: “Bonus rates get declared as a percentage of the sum assured and so it becomes very difficult to get a sense of returns. However, on an average, the returns from the bonus are not more than 4%.”
What happens if you surrender policy?
That’s usually far and the last thing in your mind when you are buying the policy. But it’s a relevant question nevertheless. Typically, traditional plans are front-loaded—a large chunk of the costs are deducted in the initial years—and so in the first three years, most traditional policies don’t have a surrender value. If you choose to surrender your policy within this period, you get nothing back.
After three years, the policy usually assumes a surrender value. Most insurers will offer two options: a minimum guaranteed surrender value—which is a regulatory requirement—and a non-guaranteed surrender value. The guaranteed surrender value is a fixed percentage of your premiums—around 30-35% of all the premiums paid minus the first year’s premium.
The non-guaranteed surrender value is arrived at more scientifically and indicates the value of your investments. The non-guaranteed surrender value depends upon the sum assured, bonus, policy term and the number of premiums paid. Since the non-guaranteed surrender value is a better reflection of your investments, it is usually higher than the minimum guaranteed surrender value. Usually in the industry, it is the minimum guaranteed surrender value that is paid out, but some insurers offer the higher of the two surrender payouts. Choose the latter option.
What happens if you stop paying premiums?
How a skipped premium will impact your benefit is also important to understand. Typically, if you skip paying a premium in the first three years of the policy, it will lapse and you will get no benefits. Some insurers may choose to pay you a discretionary sum.
However, if you skip paying a premium after three years, your policy will continue to exist but with reduced benefits. After three years, your policy assumes a cash or surrender value. Depending on this value, the insurer may settle for a reduced sum assured or may offer an extended term cover of the same sum assured for a number of years. Your policy will no longer enjoy any variable benefits.
You also need to understand the revival norms of the policy. Says Viswanand: “Some insurers allow a period of five years to renew ones policy, while others may offer only two-three years. Typically, reinstatement norms are same for all the policies of an insurer.”
If you manage to get an answer for each of these questions, you would understand your benefits and policy clearly.