Life Insurance (2)
Life insurance products can broadly be categorised as being:
1. Protection oriented policies: These products are primarily designed to cover the life of the insured and provide for a lump-sum benefit in case the life insured dies. Such products are generally referred to as ‘Term’ plans. Some key characteristics of ‘Term’ plans can be summarised as:
• Lump-sum benefit paid to designated beneficiaries only in the event of the policyholder’s death
• The lump-sum to be paid on policyholder’s death is significantly higher than what would be payable under a savings oriented plan for the same amount of premium BUT No survival benefits are available i.e. no payments are made by the insurer if the policyholder is alive when the policy completes its term
• If the policyholder stops paying the premiums when due at any time during the term of the policy, the policy ceases to have any value
2. Investment / Savings oriented policies: These products, while providing for life insurance, primarily facilitate the growth of capital on premiums paid by the policy owner. Some key characteristics of these plans can be summarised as:
• These products are primarily savings plans with attached life insurance
• Part of the premiums paid by the policyholder are treated as savings while the remaining amount is used to buy life insurance
• The policy will pay a lump-sum in case the policyholder dies during the term of the policy or will pay out the amounts saved if the policyholder is alive when the policy expires
• The lump-sum to be paid on death of the policyholder is significantly less than what would be available under a ‘Term’ plan for the same amount of premium. This is because a large part of the premium is being treated as savings and only a portion being utilised to buy life insurance
Investments / Savings oriented products can further be classified as being
o Unit Linked Insurance Plans
o Traditional Plans
Unit linked plans are life insurance plans that combine protection with investments. Although insurance plans that provide investments & savings have long been popular, both for financial planning and tax savings reasons (see Tax Benefits on Life Insurance), Unit Linked Plans are different from the traditional endowment plans. Traditional endowments are restricted in their investments by the Insurance Act to invest predominantly in government and debt instruments. Traditional Endowments have been criticised due to the lack of transparency and lower investment returns.
Unit Linked Plans, or ULIPs, combine protection with investments which are similar in structure to mutual funds. On the death of the life insured, the ULIP plan will provide for the payment of the higher of the sum assured or the fund value of the policy, to the policyholders nominees or next of kin. In the event of maturity of the policy, the ULIP plan will return the fund value to the policyholder.
Like mutual funds, Unit Linked Funds are free to set their own asset allocation and available across the risk-return spectrum including debt funds, balanced, equity funds and index funds. A policy holder thus has far greater control over where his premiums are invested.
A ULIP Plan will provide a policyholder with one or more choices of funds to invest in. The plan will charge a premium towards protection and allocate the balance of the premium paid towards investment by buying units of the fund chosen by the policy holder. These units will be bought at the NAV of the chosen fund; and the value of the policy (the fund value) will be derived by multiplying the number of units accumulated by the current NAV.
ULIP plans offer a far greater degree of transparency to customers on charges, investment allocation and investment performance.
The IRDA has mandated that detailed illustrations should be provided with each policy to highlight customer benefits and returns. The Life Insurance Council has set that the rate of returns for these illustrations at 6% and 10% per annum. Please note that these returns are indicative returns to show a policyholder the impact of investments and charges over the term of the policy at these broad rates. The actual performance of the ULIP Fund will vary depending on the asset allocation and fund type selected by the policyholder e.g. bond / income funds may have lower but more steady returns over a longer period whilst an equity fund may have higher potential reward as well as risk, and higher volatility. It is important that a policyholder select the ULIP funds carefully based on their risk appetite and tolerance.
IRDA regulations have capped charges on Unit Linked Products i.e. limiting the total charges that an insurer can deduct on a policy and limiting the surrender penalties for early withdrawal.