These days you would come across various Insurance agent 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 other than Term Plan really the best thing for you?
Let’s have a look.
Traditional plan can be Broadly classified into Term plans, Endowment policies, Money Back policies.
- Term plan or term assurance is life insurance that provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After that period expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions. If the life insured dies during the term, the death benefit will be paid to the beneficiary. Term insurance is the least expensive way to purchase a substantial death benefit on a coverage amount, over a specific period of time. 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 agents 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.
- Endowment plan is a life insurance contract designed to pay a lump sum after a specific term (on its ‘maturity’) or on death. Typical maturities are ten, fifteen or twenty years up to a certain age limit. Some policies also pay out in the case of critical illness. Policies are typically traditional with-profits.Endowments can be cashed in early (or surrendered) and the holder then receives the surrender value which is determined by the insurance company depending on how long the policy has been running and how much has been paid into it. It also offers you bonuses along the way, paid out as an accumulated lump sum on maturity if you survive the term. All said and done, an endowment plan yielding even as much as 6% per annum over a 20+ year horizon (and not all endowments yield this, some yield 4% and 5% or lesser) is a waste of your money.
- 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.
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).
You would be thinking what to do to your existing traditional policies? Should you hold or drop it?
Often clients 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 ?
- Surrender value of policy if surrendered today?
- What is the expected rate of return on the alternate investment option?
Please find the below worked example for an endowment policy with a 20 years tenure. I will derive whether 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 *|
|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. Agrawal 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, though the past returns for such long tenures are quite high we tried to be more rational & conservative here.
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.
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 seek guidance from your financial planner. Remember – d. A term plan really is the best life insurance a person could have.