Insurance Plans and Investment

Insurance Plans – Endowment Plans & ULIPs

Welcome to the Chapter on Insurance Plans, perhaps the most common forms of investment in India after savings products from banks.

Today we look at Endowment Plans or as they are more popularly known, Pension Plans, at Money-Back policies that are a type of Endowment Plans and at Unit Linked Insurance Plans or ULIPs.

But first, let us try to quickly understand insurance and why it is seen as an investment option.

Quick Introduction to Insurance

Insurance is divided into two: life insurance and general insurance.

Life insurance covers risks to life and include Term Insurance, Endowment Plans and ULIPs. Of these, we will discuss Endowment Plans and ULIPs in this chapter.

General Insurance covers risks to all non-life assets you or an organisation may have such as health insurance, motor insurance, home insurance, travel insurance and so on.

Why Insurance as an Investment Option?

Insurance emerged as an investment option because it takes care of 4 things without too much of a hassle:

• Building a Corpus for Retirement Planning
• Providing a Life Cover, which is actually what it is meant to do
• Covering Health Expenses
• Helping you Save on Tax

Its growth has been significant if you keep in mind that it is actually not an investment vehicle in the strictest sense. The reason was the lack of other small investment avenues in the initial years and limited access to stock markets until quite recently when digitisation made it possible for all Indians to invest in the stock market.

The risk of losing all the money in stock market investments has also been another reason.

The presence of LIC agents across the length and breadth of the country was also another reason as they were local people who could connect with people like you and me and talk in our language – practically and metaphorically.

The government also promoted insurance investments by giving tax benefits. The premium you pay in a year is deductible from your total income up to the specified limits under section 80C of the Income Tax Act. The maturity is also tax-exempt.

Let us now look at insurance investments.

Endowment Plans

These are insurance products that provide insurance cover against risk and offer guaranteed returns that generally include return of sum assured and bonus amounts.

Sometimes, you may get insurance add-ons called riders that increase the amount of cover or even provide additional cover against other risks such as health risks, risk from critical illnesses and so on for additional premium.

These policies are also eligible for tax benefits under the Indian Income Tax Act.

The maturity amount you get is usually offered as a lump-sum but you may also get the option to take it as a series of payments like an annuity – if the insurance company offers that option.

Understanding the Bonus

A key component of what you get at maturity is the bonus.

This bonus is usually of 3 components, speaking in a broad sense. One part is called Reversionary Bonus and may be declared every year by the company. The company may also declare Interim Bonus in the middle of the tenure. The last bonus is what you get for sticking through the entire policy term and is called Terminal Bonus or Loyalty Bonus.

These bonuses are based on the amount of cover you have chosen and not premium paid or time period of the policy.

Premium Payment

Most policies allow you to pay the premium annually, half-yearly, quarterly or monthly.

There are also single premium policies where you pay a lump sum premium for the whole policy at the start. These policies offer rebates on the premium if you go for a higher sum assured.

Returns on Endowment Plans

In terms of returns, the best returns on these polices are around 7-8% if you take a basket of plans while the average returns is usually around 4-5% for single plans.

This is why most experts ask investors not to put all their investments in pension plans but combine it with other investment options.

It is suggested that you go for longer tenures as this helps to increase the overall returns that you will get at the end of the policy term.

Money-Back Policies

These are a type of endowment policies where you get certain amounts of money at regular intervals. Due to this, the amount you get back as a lump sum at the end is not as big as the one you would get for a standard endowment policy without any money-back.

Since these policies allow you to get money at regular intervals, you can plan for specific life events such as home renovation, college fees for kids, foreign education costs or overseas travel, among others. This is especially important if the person has poor money-saving habits as they will probably not be able to plan and take care of those expenses when they appear.

Unit Linked Insurance Plan (ULIP)

Unit Linked Insurance Plans offer a mix of insurance and investment options.

The goal is to give you wealth creation opportunities along with life cover.

Here, the insurance company segregates your premium or investment amount into life insurance premium and into investment amount that is put into equity or debt or both as per your preferences. You can change the allocation of where your investment is made – how many times you can do so depends on your insurance company. Sometimes, your age also influences how much you can invest and where.

There is a lock-in period for ULIPs – which is 5 years. But it is suggested that you stay invested for 15 years or more if you want to see better returns from your ULIP investment.

The long-term ensures that market fluctuations do not affect your returns.

The Two Types of ULIPs

Insurance companies in India offer 2 types of ULIPs, called Type 1 and Type 2.

In Type 1, the insurance company pays the nominee the sum assured or the accumulated fund value, whichever is higher.

In Type 2, it pays the nominee the sum assured and the accumulated fund value.

Since the risk associated with Type 2 is more for the insurance company, this is reflected in the premium. The premium for Type 2 plans is usually higher.

Now let us look at something most people are unware of but which affects your returns in ULIP investments.

Fees and Charges in ULIPs

Fees and charges in ULIPs add up.

There are certain charges that you need to keep in mind if you invest in ULIPs.

The first: Premium Allocation Charges

This is deducted as a fixed percentage from the premium paid in the initial years of the policy. Since this is charged at a higher rate, there is a significant variation between your premium or investment and the actual investment. These charges include the initial and renewal expenses and intermediary commission. It is often called a front-load charge as it is deducted from your premium.

The second: Mortality Charges

This is charged on a monthly basis to provide you with the insurance coverage under the plan. The mortality charges depend factors such as age, the sum assured, and so on.

The third: Fund Management Charges

This is the fee taken by the insurance company for managing the various funds in the ULIP. The maximum charge allowed is 1.35% per annum of the fund value and is charged daily. Usually, the charge is higher if you choose to invest in equity funds and lower for debt funds.

Another set of charges are Policy Administration Charges

These are levied for the administration of the policy and are deducted on a monthly basis by cancelling certain units from the chosen funds.

In addition to these four, there may be Partial Withdrawal Charges and Charges for Switching Your Funds.

Since there can be 4-6 charges on your ULIP, it is important that you find these charges and know of their possible effect on your premium before you start to invest. The individual percentages or charges may seem small but add up over the years to a sizeable amount.

Returns on ULIPs

The returns on ULIPs are definitely better than that for traditional endowment plans. Unlike endowment plans that offer 4-5% on an average, the ULIPs give you market returns.

So, choosing funds that invest in equity may give you returns in excess of 10% though it will be dependent on the market. You are more likely see different returns in different years due to the nature of the equity market. On the other hand, if you invest in debt funds your returns may be a bit lower than 10%, maybe around 6-8% but will be more stable.

Take-Away

For all of these investments, Endowment Plans or ULIPs:

• The first thing is to Define Your Goals – so you know when and why you need the funds
• Second is to Compare the Returns offered by different companies vis-à-vis the premium they charge
• The third thing is to Stay Invested for the Long-Term. Choosing to cancel an endowment plan will mean you will get only a part of the premium you have paid. Getting out of a ULIP after the lock-in period is over means that you will get lower returns unlike what you would get if you stay invested for the long-term.
• Fourth is to Look Beyond Taxes. Most insurance investments are seen as a way to reduce tax liability. Though it is a valid way to look at them as the amount you invest qualifies for deduction (upto a limit) and the returns on maturity are also tax-exempt. Only looking at tax savings, however, may deter you from seeing the long-term view which is to grow your wealth.