Whenever we think of buying any insurance policy, this is the question which pops up in our mind. Whether to buy a plain Term Insurance policy or to go in for ULIP/ Endowment plan. Answer to this question lies in our expectations with our insurance plan. Are we looking at insurance as a pure insurance cover or as an investment option?
In recent days it has become fashionable to discourage investors from buying unit linked insurance plans, ULIPs.
The reason: High administrative, mortality and fixed annual charges. Instead, term insurance plans offer better insurance to the life covered, so goes the argument.
While each and every insurance product has its advantages and disadvantages compared to other such similar products, insurance buyers must understand their need for insurance before buying any insurance product.
One of our friends wanted to take a life insurance cover. He had taken a home loan of Rs 45,00,000. He wanted a matching life cover to ensure that in the event of anything happens to him, the maturity proceeds from the insurance could be used to repay the housing loan. He had two options before him.
Either buy a term plan or go in for a ULIP. We looked around for a number of options for a term plan. Given below are the quotes from various insurance companies for a life cover of Rs 45,00,000 for a person aged 32 years. The term of the cover is 25 years.
|Life insurance company||Life cover (Rs)||Premium per annum (Rs)||Term (In years)|
|LIC of India||45,00,000||16,110||25|
|Tata AIG Life||45,00,000||16,609||25|
The least cost premium, we found was Rs 15,496. This looked good. But he had to pay this premium for the next 25 years.The total premium payout would have been Rs 387,400.
He was also suggested to consider a ULIP with the following features:
- Premium per year would be Rs 30,000
- Minimum premium payment term of 3 years. Can continue the premium payment if he wished at a later stage
- Maximum life-cover availability. In this case the life cover was Rs 45,00,000
- Investments in ULIP to be in Maximiser, an option where the investments are into equity products like mutual funds and hence potential for higher returns
Given below are the administration charges and the insurance charges deducted from the premium:
|Administration charges (Rs)||Mortality charges (Rs)||Fixed annual charges (Rs)||Total charges (Rs)||Amount invested (Rs)|
The total of the administration charges, mortality charges and fund management charges for all the three years put together works out to Rs 37,202. If one were to take the term plan premium into consideration, the total premium outflow would have been Rs 15,496*3 = Rs 46,488.
Premium as per term plan = Rs 46,488
Charges as per ULIP = Rs 37,202
Effective savings = Rs 9,286
Now let us look at this from the investment angle too.We compare the returns of this ULIP with two different mutual funds with two different objectives.
In the ULIP, after deducting all the applicable charges towards insurance, administration and fund management, the balance amount of Rs.52798/- would have appreciated to Rs 75,225 if we take the rate of return @ 25% per annum based on the rate of returns in 2006 and 2007. The same investment in Reliance Growth Fund stands at Rs 69,801 and in HDFC Tax Saver Fund stands at Rs 79,173.51.
In ULIPs, the obligation towards the front loaded insurance premium payment is completed after the first three years of premium payment is made. This means for our friend, after three year obligation to pay insurance premium will be over. Afterwards, after deducting an amount of around 3% as reduced insurance premium and standard administration charges of around Rs.750 per year from Rs 30,000 (annual premium paid by our friend) will be available towards investment in mutual funds or equities by the insurance company.
Had our friend opted for a term plan, the situation would have been totally different. He would have paid the term premium charges of Rs 15,496 for the next 22 years. Consequently, the amount available for investments in each of the next 22 years would have been Rs 14,504. It is elementary mathematics that Rs Rs.28, 350/- (30,000- 900 (insurnace premium) – 750 (admin charges)) invested over a period of 22 years will compound itself much higher than Rs 14,504.
One of the drawbacks of ULIP is that in case of death, either the sum assured or the fund value, whichever is HIGHER is paid and not both.
To illustrate, if something were to happen to our friend after 20 years, his family would get back Rs 45,00,000 only. Had he opted for the term plan, then his family could have liquidated the mutual fund holdings yearly investment of Rs.14504/- per year made by our friend which would be around Rs.15 lakhs (@ 15% annual return) and in addition our friend’s family would also have got Rs 45,00,000 from the insurance company.
The factor mentioned as an advantage for ULIP is the obligation to pay the premium for three years only for covering the life throughout the term of the ULIP. To some extent this itself is a deceptive drawback as your insurance will continue as long as you pay your yearly premium is paid which is to be utilised for investment in equity by the insurance company. If you intend to discontinue your annual premium, then the insurance premium will be deducted from your NAV available with insurance company to keep the insurance aspect alive. It is worth to quote here the terms and conditions of an insurance company as for as discontinuance of premium is concerned.
“What happens if payment of premiums is discontinued?
a) Discontinuance within three years of commencement – If all the premiums have not been paid for at least three consecutive years frominception, the insurance cover shall cease immediately. Insurers may give
an opportunity for revival within the period allowed; if the policy is not revived within that period, surrender value shall be paid at the end of third policy anniversary or at the end of the period allowed for revival,
whichever is later.
b) Discontinuance after three years of commencement — At the end of the period allowed for revival, the contract shall be terminated by paying the surrender value. The insurer may offer to continue the insurance cover, if so opted for by the policy holder, levying appropriate charges until the fund value is not less than one full year’s premium. When the fund value reaches an amount equivalent to one full year’s premium, the contract shall be terminated by paying the fund value”
On the other hand, one of the advantages of Term Insurance is even by incurring a small amount you can make your family safer in your absence. In other words, those who is not afford to incur or does not want to incur more amount for insurance yet want to leave behind his family with hefty sum of money can go in for Term Insurance. For an instance by paying premium of around Rs.6000/- per year one can insure his life for Rs.20 lakhs (premium rate for person at the age of 30). Whatever, the remaining amount you have for savings is at your disposal and not in the hands of Insurance Company. In contrast, one who can afford to pay more money to invest every year can only go in for ULIP for assuring the same amount of Insurance coverage.
If we see these things in the other way around, those who have buffer money yet not prudent enough to invest in equity or mutual fund can go in for ULIP, which would take care of investment as well as the insurance. But the cost you pay for that is more by way of paying higher insurance premium to the tune of around 25 % per annum for first 3 years and around 7% for the remaining years.