Up to a few months ago, ULIPs were being pushed in a big way. An insurance product that helped you also invest in the equity markets, in a single contract, was being touted as a dream product come true.
Research was done and efforts to educate the investor have since rubbished these claims of godliness. Stories of this high commission product that had not yet even proved itself, with unscrupulous agents hard-selling them to unaware customers who didn’t even need these policies, made news time and time again.
Regulators stepped in, and ULIPs are now recovering from the bad press, quietly. Advisors are reluctant to really sell ULIPs, for fear that the client now knows that he will be getting a bad deal, and will not trust the advisor anymore. And lack of trust is one of the worst things that can happen to an advisor from his client.
So advisors are now selling traditional plans. Once again they are insisting that traditional plans are excellent, there is no market risk, the maturity value is assured, and everybody must have these policies.
But have insurance agents truly started working on your behalf instead of their own? Is a traditional plan really the best thing for you?
Let’s have a look.
What is a traditional plan?
Term plans, endowment policies, money back policies, pension plans – these are called traditional plans.
A term plan gives you life cover, with no maturity or interim benefits. Premiums are the lowest for this type of policy, and for this low premium, your family will get the highest benefit. A Rs. 10 lakh term plan for a 35 year old with a 20 year policy tenure will cost around Rs. 5,000 per year. Only very few advisors are actively selling this type of plan.
As customer wants evolve, so do industry offerings.
Customers weren’t always satisfied with the idea of no maturity benefit upon surviving the term of the policy, because a maturity benefit would help build up a retirement corpus, and so endowment plans were born.
An endowment plan offers you life cover, charges you higher premiums than a term plan, and gives you a maturity benefit. So if you survive the term, you will receive some amount of money as a maturity benefit, unlike in the case of a term plan. It also offers you bonuses along the way, paid out as an accumulated lump sum on maturity if you survive the term. over a 20 year tenure, your endowment plan, if you include bonuses, could yield you up to 8% per annum.
By itself, this return seems average, not poor. But, keep in mind this is over a horizon of 20 years.
In 20 years, considering inflation, your premiums will not be providing you much return at all. And a good diversified equity mutual fund will yield you double of this per year, beating inflation and giving you a return on your investment.
All said and done, an endowment plan yielding even as much as 8% per annum over a 20 year horizon (and not all endowments yield this, some yield 5% and 6%) is a waste of your money.
A money back policy is nothing but an endowment plan that’s been dressed up a bit.
While an endowment plan will give you a maturity benefit on surviving the entire term, a money back policy pays out for every few years of survival. If for example you take a 20 year money back policy, you will get some proportion (say 25%) of your Sum Assured every few years, say every 5 years. You will also get your remaining Sum Assured plus accumulated bonuses, on surviving the entire term.
Yield on a money back policy sometimes comes to a little more than yield on an endowment policy, considering that once you get the interim pay outs, you can invest them on the spot.
But overall, endowment policies and money back policies are poor performers, especially considering the fact that the tenure is so very long (20 years, 25 years, 30 years).
So what do you do if you’ve already got one of these traditional policies? Should you drop it?
Often we come across clients who have a number of such policies, having been sold multiple identical policies with different tenures by their agents. They want to know if they should drop their insurance policies.
This depends entirely on 3 things:
- What is the remaining policy tenure i.e. how many premiums are yet to be paid?
- If the policy is surrendered today, what will be the surrender value?
- What is the expected rate of return on the alternate investment option? i.e. if you are not paying premiums, where will you be investing the saved premium amount?
Consider the case of Mr. Shah again, who has an endowment policies with a 20 years tenure.
Would it make sense to drop any one of these policies and invest the surrender value and remaining premiums into mutual funds?
See the table below:
|Years ||Endowment Premium ||Surrender Value of Endowment ||Term Premium ||Premium saved & invested in Mutual Funds ||Return from Mutual Funds @ 12% ||Benefit / Disadvantage * |
|0 ||24,632 ||- ||2,059 ||22,573 ||1,821,613 ||751,613 |
|1 ||24,632 ||- ||2,059 ||22,573 ||1,603,867 ||533,867 |
|2 ||24,632 ||24,893 ||2,059 ||22,573 ||1,600,877 ||530,877 |
|3 ||24,632 ||51,354 ||2,059 ||22,573 ||1,588,464 ||518,464 |
|4 ||24,632 ||69,138 ||2,059 ||22,573 ||1,504,721 ||434,721 |
|5 ||24,632 ||89,341 ||2,059 ||22,573 ||1,431,511 ||361,511 |
|6 ||24,632 ||112,249 ||2,059 ||22,573 ||1,367,515 ||297,515 |
|7 ||24,632 ||138,147 ||2,059 ||22,573 ||1,311,429 ||241,429 |
|8 ||24,632 ||167,422 ||2,059 ||22,573 ||1,262,400 ||192,400 |
|9 ||24,632 ||200,422 ||2,059 ||22,573 ||1,219,362 ||149,362 |
|10 ||24,632 ||237,516 ||2,059 ||22,573 ||1,181,352 ||111,352 |
|11 ||24,632 ||274,896 ||2,059 ||22,573 ||1,135,863 ||65,863 |
|12 ||24,632 ||316,940 ||2,059 ||22,573 ||1,095,690 ||25,690 |
|13 ||24,632 ||364,504 ||2,059 ||22,573 ||1,060,870 ||(9,130) |
|14 ||24,632 ||418,623 ||2,059 ||22,573 ||1,031,454 ||(38,546) |
|15 ||24,632 ||480,461 ||2,059 ||22,573 ||1,007,348 ||(62,652) |
|16 ||24,632 ||555,533 ||2,059 ||22,573 ||994,972 ||(75,028) |
|17 ||24,632 ||640,292 ||2,059 ||22,573 ||984,875 ||(85,125) |
|18 ||24,632 ||735,995 ||2,059 ||22,573 ||976,829 ||(93,171) |
|19 ||24,632 ||844,008 ||2,059 ||22,573 ||970,571 ||(99,429) |
|20 ||Maturity Value incl. Bonus (Rs.) ||1,070,000 || || || || |
* (Return from MF minus Endowment policy Maturity Value)
The premium paid for the endowment policy is Rs. 24,632 per year. The premium paid for an equal sum assured (Rs. 5 lakhs) term plan is Rs. 2,059. The difference is Rs. 22,573 of additional premium every year.
The table above examines whether it makes sense for Mr. Shah to drop the policy and invest the surrender value received and the remaining premiums (that he would have paid) into mutual funds, assuming a return of 12% per year from the mutual fund.
Consider Year 7, the year of his 8th premium (as the count starts at Year 0).
If he surrenders the policy in this year, he will receive Rs. 138,147 as the surrender value. He can invest this surrender value and also invest the remaining premium amounts (Rs. 22,573 per year for the remaining years) into mutual funds, and the money he invests would grow to Rs. 13,11,429 by the end of the 20 year period. This is a surplus of Rs. 2,41,429 over Rs. 1,070,000 what the endowment policy would have paid him.
Now consider Year 17 i.e. the year of his 18th premium.
If he surrenders today, he will receive a surrender value of Rs. 6,40,292. He can invest this corpus and the remaining premiums into mutual funds, and the corpus accumulated within the next 3 years would be Rs. 9,84,875. This is less than he would receive is he simply continued with the endowment policy. The benefit of continuing the policy is Rs. 85,125.
In this particular case, the break-even year was Year 12. If he surrendered anytime up to and including Year 12, it would make financial sense for him to drop the policy and invest the surrender value and remaining premiums into mutual funds.
Anytime after Year 12, it would be more financially prudent to keep the policy.
Your Action Plan
Now you know exactly what a traditional policy is all about. If you have these policies, then depending on how long you have had it, what the surrender value would be, and what rate of return you would get on your alternate investment, you can decide whether you would like to keep the policy or not.
Else, you can always speak to your financial planner, who will create a customized insurance plan for you. And remember – with a straightforward term plan, you don’t have to worry about whether your money is being effectively utilized. A term plan really is the best life insurance a person could have.