2016-05-04 13:30:00 UTC
As we’d mentioned in our first post, we are expanding our coverage on various insurance-related topics, and explaining the basics. This post talks about the types of life insurance.
The most common reason people buy life insurance is to replace their income and maintain their family’s well-being and lifestyle after their death. However, there are situations when people need solutions that will meet their dual needs of life cover and wealth creation over time . Although most financial advisors recommend keeping investment and insurance separate and favour term life policies over others, no two individuals are the same, and some prefer the disciplined approach to saving for the future that whole life policies and pension plans offer, as opposed to investing only in mutual funds or Fixed Deposits. It is therefore important to choose the plan that suits your approach to life and investment as an individual.
There are, broadly speaking, 5 types of life insurance:
Term Life Insurance
The simplest form of life insurance. You pay a premium every year, and if you expire during the term of the policy, the benefit (AKA sum assured) is paid out to your beneficiary.
There is no payout if you survive the term of the policy. Term life policies generally have the lowest premiums out of all life policies.
There are two further classifications within term life insurance—level term and decreasing term.
It is common for an individual to buy a life cover that lasts until his retirement age, based on the simple logic that the individual would have accumulated sufficient wealth and retirement savings to make continued life cover beyond retirement unnecessary.
Whole Life Insurance
Whole life or permanent life insurance is basically term life, but over the entire lifespan of the policy holder. You, as the policy holder pay premiums every year until you die, and upon your death, the sum assured benefit is paid out to your listed beneficiary. There is no pre-defined term or tenure for the policy.
Both term insurance and whole life insurance use the same mortality figures and probability factors for calculating insurance costs, but the premium costs for whole life insurance are considerably greater than term insurance premiums, as a payout is a certainty with whole life policies.
Because of this, a potential pit-fall with whole life policies is under-insurance. Since it is substantially more expensive than term life plans, there is a danger of policyholders buying whole life policies with premiums they can afford, rather than focus on buying adequate life cover for their dependents.
Endowment plans are a lot like term life plans, with a major difference: endowment plans pay out at the end of the policy term regardless of policy holder’s survival. When the policy expires, you get the payout if you survive, and your beneficiary does if you don’t.
The premiums you pay are generally invested by the insurer, and at the end of the policy term, you get paid sum assured plus profits.
Typical maturities are between 10 and 20 years. Some policies pay out in the case of critical illness too. Endowment polices provide a moderate tax-free returns of 5-6%, which the policyholder can enjoy in his life term.
The annual premiums for endowment policies are an order of magnitude higher than say term insurance (roughly 10 times), but the policy forces a policyholder to be disciplined and save religiously, as the surrender charges for termination are high and is a deterrent against default on premium payments.
The endowment policy is suitable for people who have a low investment risk appetite and those who do not have a knack for investment, as they rely on their fiscal discipline and tax breaks to create modest savings and wealth. The investment is secure as the premium is invested in government bonds with no risk of loss of capital.
Money back Policy
These are an extension of endowment plans. In addition to the usual benefits of endowment plans, money back policies pay out a specific amount in regular intervals (usually annual, but can vary from insurer to insurer).
If the policy holder survives the term of the policy, the balance sum assured is paid. If the holder doesn’t survive, then the full sum assured is paid to the beneficiary.
An important aspect of this policy is that in the event of death at any time within the policy term, the payout includes full sum assured without any deduction of the survival benefit payments, which have already been paid. Moreover, the bonus is also paid on the full sum assured. Money-back plans are for those who want an investment plan with a life insurance component, which is made further attractive by tax exemption.
In the case of a 20-year Money-Back Policy from LIC, 20% of the sum assured becomes payable each after 5, 10, 15 years, and the balance of 40% plus the accrued bonus become payable at the 20th year.
Unit Linked Insurance Policy(ULIP)
Unit Linked Insurance Policies belong to both the insurance and the investment category: where one gets to enjoy the benefits of both insurance and investment.
ULIPs differ from traditional endowment plans in certain areas. As the name suggests, performance of ULIP is linked to markets. Individuals can choose the allocation for investments in stock/debt markets.
While a part of the monthly premium pay-out goes towards the insurance cover, the remaining money is invested in various types of funds that invest in debt and equity instruments. ULIP plans are more or less similar to mutual funds except for the difference that ULIPs offer the additional benefit of insurance.
ULIPs have come under severe disapproval from financial advisors in the past, because of hidden charges that are not transparent and poor investment value. IRDA has addressed these shortcomings to make the plans more customer friendly. ULIPs have a longer lock in period compared to Equity Linked Savings Schemes but provide modest returns to individuals who prefer keep insurance and investment together especially over a longer term.
To put things in perspective, here is a rudimentary comparison of the premium costs for various policies based on the following requirements : a male, 30 years of age , policy term ~20 years and Insured sum Rs 30 lakhs. As you can see, Term life policies are considerably cheaper.
Buying Life insurance could perhaps be the most significant financial decision you ever make in your lifetime.
Life insurance is an indispensable piece of your financial planning and de-risking strategy to safeguard your family’s dreams & financial security.