21 November, 2009

Which insurance is the right one for me?

Each insurance plan has it’s merits and should be used according to specific requirements of the individual

Pritam was by now exhausted by the arguments and counter arguments on the merits or otherwise of insurance. Kavya, his wife was enjoying this wholesome banter with her cousin, Vaibhav. Vaibhav was giving all reasons why insurance is a must and Kavya was playing the devil’s advocate.

“Of what use is an insurance to a person, if the money will come only after his death”, Kavya was presently positing. Vaibhav was in no mood to back off. “A person would take such an insurance to protect the family if the income earner were to pass away, prematurely. Since, the income would stop & expenses won’t, a replacement is necessary. That is the purpose of most insurance policies”, he chimed.

He took a swig of the soft-drink and was off again. “There are many kinds of insurance policies to suit the requirements of various types of people. You have money-back policies, from which you would get a pay-back at regular intervals & an Unit-linked policy which allows the flexibility of withdrawals after a certain number of years. Endowment policies on the other hand, pays back the Sum Assured & the bonus at the end of the term. So it is not that in all policies the life insured will not get to see the money during his lifetime”.

This interested Kavya. She wanted to know more about these policies. Vaibhav was more than happy to oblige. He has not had a more obliging audience in all these years as an insurance agent. He straightened up in an effort to enlighten & empower.

“Endowment policy is a insurance cum investment plan, where there is a life-cover for the entire term. Also, the policy holder gets at maturity, the Sum Insured ( which is the life cover opted for ) and the bonuses declared year on year, till maturity. Typically, the premium payment is also for the entire term, although shorter premium paying terms are also available in some policies. Typically, endowment polices have given between 5.5% to 7.5% returns, based on the age, tenure and type. Since insurance returns are not taxed at maturity ( in most cases ), these are post-tax returns. That makes it doubly interesting”, Vaibhav summed up.

“If this is so good, why have people not been buying this policy?”, Kavya wondered. “It is not that people are not buying this. Endowment policy have given returns comparable or even better than FD/ NSC/ bonds etc. in addition to giving insurance cover. Hence, it is attractive. This was one of the most sold policies till about 6 years back. Then, Unit Linked Insurance Plans ( ULIPs ) came in and swept the market. After that, all traditional policies have been relegated to the background”, said Vaibhav.

“What about Money back policies? Are these not sold today? I found it interesting when I had bought them”, queried Kavya. Vaibhav gave his cousin Kavya an approving nod. For once, someone is hearing him out with genuine interest. “ Money-back policies return a portion of the Sum Assured at regular intervals of three to five years. At the end of the term, bonuses along with any residual sum assured to be paid, is given out. Since, money is given out at regular intervals ( and is probably used up ), the return without reinvestment is between 3.25% to 4.5% depending on age, tenure of policy & type of policy. Irrespective of this, Moneyback policies were pretty popular as they give some cashflows at regular intervals. Again, ULIPs were the game changer, which all but killed this product type”.

“I have been reading & hearing about ULIPs everywhere. Though I know something about it, I would want to hear it from the horse’s mouth”, said Kavya with a smile. Vaibhav launched forth. “ A ULIP is a combination of investment & insurance plan. In the traditional insurance polices, the investments are done by the insurance company, without any discretion of the client coming in. Hence, the investment risk is with the insurance company ( and indirectly borne by the insured, as the returns will affect the bonus paid, year on year ). However, in a ULIP, the investible portion is invested in one or more funds ( maintained by the company ), specified by the client. The funds range from Equity to debt funds, including hybrid funds. Many understand that the returns from ULIPs can be substantially higher as compared to a traditional Insurance product. They are right. If invested for a long period of time, the investment returns will indeed be higher than a regular insurance. However, the risks are higher too, as upto 100% of the investible amount could be invested in equity.” He paused.

“But ULIPs are the flavor of the season. One of the reason is the returns that it offers; the second is the flexibility – in premium payment term as well as in accessing the accumulated funds when necessary. The insurance advisors are also smitten by this as it is easy to sell, in view of the tremendous flexibility as well as the good returns, it has been able to deliver in the past. ULIPs have comparatively high charges for premium allocation in the initial years which tapers down or could even become zero in future. Very often ULIPs are compared to the combination of term insurance plus an Equity MF scheme. Some of the ULIPs are able to beat the term + MF combination post 10 years, assuming that both give a similar return. However, the jury is still out on this”.

“The other main category is the term insurance plan. Here, one pays a premium to cover the life risk and nothing is returned at the end of the term. The premium paid is substantially less than any other category of life insurance. The life cover is substantial in this policy and comes in handy if there is a death claim. This is the only really viable option if one wants a substantial cover. Some of the ULIPs that have come in today also allows one to take a substantial cover and they resemble a term insurance policy.”

“Each of these products has a role to play. What works for a person may not work for another. For instance, an Endowment product may work well for a young person taking a long-term cover. A ULIP will be useful for someone who wants the flexibility and is ready to assume some risk. A term policy is useful to another who wants to put in place a big life insurance safety net. It could be a bouquet of products which one could structure according to one’s needs”, he ended. At this point, Kavya got up and applauded. Pritam joined in and gave Vaibhav a standing ovation.

Published in Money Mantra Nov 30 2nd issue

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