Traditional Life Insurance Plan : – Insurance could be a contract that provides protection against a possible eventuality or risk. So, insurance in its purest kind is an expense rather than an investment.
Unfortunately, several people combine life insurance and investment. we tend to expect Returns from our investment in life insurance. investment in a very traditional life insurance plan is one in every of the foremost common personal finance mistakes that a lot of people commit.
What are traditional or typical life insurance Plans? – traditional plans or typical plans are the oldest kinds of insurance plans on the market. term insurance plans, Money-back plans, Whole-life Plans, Endowment plans etc., are thought of as conventional plans. traditional policies are thought of as riskless, as they provide fixed returns just in case of death (or) on policy maturity.
What is an Endowment plan? – It is a combination of insurance and investment. The insured can get a lump sum along side bonuses (if any) on policy maturity or on death event.
What are Money-back policies? – They provides life coverage throughout the term of the policy and therefore the maturity benefits are paid in installments (at periodic intervals) by method of survival benefits.
What is Whole-Life Insurance Plan? – it’s a life insurance policy that is guaranteed to stay in effect for the insured’s entire lifetime. The sum assured is paid to the Policyholder’s nominee within the event the insured dies.
The common thing with these policies is that they provide bonuses to the policyholder. Bonus is obtainable on traditional plans that are inbuilt to the plan structure. These bonuses is of different types like easy reversionary bonus, Loyalty addition, Final extra bonus etc., So, traditional plans have 2 components i.e. i) Life cover & ii) Investment component.
Traditional Life Insurance Plan & Premium amount
As mentioned above, an insurance provides risk protection. you’ll get the risk cover by paying a definite amount as Premium. in a very traditional life insurance plan a part of the premium goes towards mortality charges (for life cover) and the remaining is invested primarily in Debt or fixed income Securities.
(What are Mortality charges? – Mortality Charge is the quantity charged each year by the insurance company to provide the life cover to the policyholder on the lifetime of the Insured. it’s additionally known as cost of Insurance.)
As these traditional plans need to pay BONUSES to the policyholders, they need to charge over and above the ‘cost of insurance’. this can be the reason why the endowment plans or money-back plans ar costlier than the pure term insurance plans.
For example : Arun pays a premium of Rs 10,000 towards his life insurance arrange for sum assured (life cover) of Rs 1,00,000. His life insurance company deducts a part of this Rs 10,000 premium because the ‘Cost of Insurance’ or ‘Mortality Charge’. this can be kept aside by his insurance firm and maintains a ‘Life Fund’. This Life Fund isn’t invested anyplace. insurance firm uses this Fund to pay out Death benefits.
Mortality Charge is typically a very bit, say Rs 400 p.a. from the Rs 10,000 annual premium that Arun paid for his life insurance. From the remaining amount of Rs 9,600 (Rs 10,000 – Rs 600) varied expenses like workplace administration, marketing expenses, policy maintenance etc. are deducted and therefore the balance amount would go for investment.
Why Traditional Life Insurance Plan is a bad Investment?
- High value of Insurance & Low Life cover : As mentioned above, the premium rates on traditional plans are a lot of higher than the term insurance plans. If you’re buying an Endowment plan or money-back policy always cover then kindly note that you just are paying a very high premium for a low life cover.
- Low Investment Returns :
- The conventional plans may be of 2 types – i) participating Insurance plans & ii) Non-participating insurance plans.
- In case of participating plans, the investment returns are primarily dependent on the bonuses declared over the Policy term by the life insurance company.
- In case of Non-participating traditional plans, the death and maturity edges are clearly mentioned upfront.
- That means a policyholder knows what he/she goes to get at maturity or on death.
- In each the cases, most of the traditional life insurance plans provide investment returns of around 3 to 5.
- So, in terms of life cover you pay high premium & you get low life cover and at a similar time in terms of Returns too, you get a meager return on maturity.
- Percentage of Returns aren’t guaranteed : The plans that fall under the class of ‘Participating plans’ the percentage of returns aren’t guaranteed. the rate of bonuses declared by a life insurance company will vary from year to year. the product brochures clearly state that the rate of return is for illustration purposes solely. So, kindly bear in mind of this point.
- Terms & Conditions on Bonuses : Bonuses like Loyalty addition or Final additional bonus might or might not be applicable on all traditional plans. they will be applicable based on the quantum of sum assured and/or policy term.
- No compounding effect : The bonus (simple interest bonus) declared by most of the Endowment plans or Money-back plans doesn’t compound itself. for example, let’s say your life insurance company declares bonus of Rs 40 per 1000 of sum assured for 2 consecutive years. If you have got invested in an Endowment plan of sum assured Rs 1 lakh, when two policy years you’ll receive a bonus of Rs 8,000 (Rs 4,000 + Rs 4,000). This Rs 8,000 would stay as Rs 8,000 till the maturity of the endowment policy. it’s simply accrued and compounding doesn’t come into picture.
- High Penalty : If you choose to surrender a traditional life insurance plan within the initial years, you’ll end up paying a hefty penalty. you’ll surrender the policy for money only when the premiums have been paid for a minimum of 3 policy years.
- Tax saving is an additional benefit : Insurance is primarily for protection and not for saving Taxes. Kindly note that Tax saving is an extra benefit, that’s it!
- Erosion of wealth : life insurance policies are long-term contracts. once you are investment for long-term, would you prefer to get good inflation adjusted returns or not? Your endowment or money-back plans are low-yielding investments. these could offer you negative inflation adjusted returns.
Do not blindly go by projected illustrations given by your agents or advisors. a traditional policy might look attractive these days by viewing the projected maturity corpus. But, forever factor inflation into the calculation. For example: you’ll be offered a maturity worth of Rs 50 Lakhs in 20 years. At 6 June 1944 inflation the today’s worth of it’ll be reduced to Rs 15.6 Lakh.
Remember this simple point : “Any life insurance plan that pays cash before a policyholder dies is best avoided.” Else you’ll end up buying costly and unwanted life insurance plans.
Then, who can purchase these traditional life insurance plans? If you have already got adequate life cover, would like to safeguard your capital, and happy with lower (or negative , inflation effect) long-term returns then you’ll consider investing during a traditional life insurance plan. Even during this case it’s not an INVESTMENT option however it’s simply a long-term SAVING option!