Three Kinds Of Life Insurance Policies

Few things in the world of Personal Finance are as confusing as Life Insurance policies. Even seasoned investors often find themselves at their wits ends as they trawl through the jargon-laden policy brochures. Adding to the confusion is the fact that agents, in their desperation to close sales and earn a hefty upfront commission, often do not explain product features properly, or explain them in a manner that does precious little to help policy buyers make well-informed decisions.

Fortunately, once you condense them to their most granular form, only three kinds of policies exist. These are - traditional plans, unit-linked plans, and term plans. Each of these policy types have their nuances that are typical to them. So, the next time you're sitting with a verbose Life Insurance agent who is making your head spin - take a pause and ask him/her this: what kind of policy is this? Once you've got your answer, refer to the ready reckoner below and you'll find yourself having a lot more clarity than before.

Traditional Plans
Traditional Plans, also known as 'non-linked' or 'participating' plans are touted as the 'low risk' variant of Life Insurance policies. You pay either a single or recurring premium, and are provided a sum assured in exchange. Bonuses (declared as a percentage of the Sum Assured) are added to your premium payments at the end of each year. Bonus rates depend upon the performance of the insurer itself, and vary year on year, and insurer to insurer. The 'returns' come to you as a maturity value lump sum, or periodic cash flows at the end of the policy term (for money back policies). These policies usually provide very low returns (in the range of 4%-6% per annum these days, and have very poor liquidity. Whole Life Plans, Endowment Plans, and most Child Education Plans fall under this category.

Pros: Capital Guarantee - but at what cost?
Cons: Low Returns, Low Liquidity, Low Death Benefit (they don't really serve the purpose of insurance OR investment)

What to watch out for: Ask your agent to provide you with the historical bonus rates for the insurer he represents (in written, preferably)

Unit Linked Plans
Unit Linked Plans or ULIP's aim to combine Insurance with Investments. They used to have exorbitant costs associated with them until 2009, with some ULIP's deducting as much as 70% of your first-year premiums towards costs! Post 2009, IRDAI rolled out a slew of reforms in this space, essentially making them a lot more investor friendly. With a ULIP, you can customize the death benefit associated with your policy. The higher the death benefit you choose, the more the 'mortality costs' that will be deducted from your fund value on an annual basis (this is not a bad thing, by the way). Despite reforms, many ULIP's still have a plethora of charges and costs associated with them. Agents do not actively sell ULIP's anymore, as they are not lucrative in terms of commission pay-outs. As products, ULIP's score over their traditional counterparts, as they have a higher potential for long term wealth creation, and better exit options too.

Pros: Market Linked Returns
Cons: Higher costs than Mutual Funds, usually poorly sold by agents and therefore may provide you with a low death benefit

What to watch out for: Fund Performances, and your own asset allocation - don't assume that your agent has picked the right funds for you

Term (Pure Risk) Plans
Term Plans are pure risk transfer plans. In a sense, they function just like motor or health insurance policies, as they have no savings element or maturity value. You pay a premium for a fixed number of years, during which your family is secured against the financial strife that would accompany the loss of your life. With Term Plans, you can acquire a very high death benefit (such as 1.5 to 2 Cr) at a very low annual cost. TROP's (Term with Return of Premium) are a variant of Term Plans which give you back your premiums at the end of the policy term, but they aren't financially lucrative. It's best to opt for the plain vanilla variant which doesn't provide you with any money back at the end.

Pros: High Death Benefit - they truly serve the purpose of safeguarding your family
Cons: No savings element/ maturity value - but so what?

What to watch out for: the claim settlement ratio of the insurer you're considering - look up the IRDAI website.