Traditional Life Insurance Plan – A Terrible Investment Option?
Traditional Life Insurance Plan: – Insurance could be a contract that provides protection against a possible eventuality or risk. Therefore, insurance in its purest type is an expense rather than an investment.
Unfortunately, several people combine life insurance and investment. We tend to expect returns from our life insurance investment. The investment in a very traditional life insurance plan is one of each of the main common personal finance mistakes that many people make.
What are the traditional or typical life insurance plans? – Traditional plans or typical plans are the oldest types of insurance plans in the market. Long-term insurance plans, repayment plans, whole life plans, endowment plans, etc., are considered to be conventional plans. Traditional policies are considered to be risk-free, since they provide fixed returns in the event of death (or) in the maturity of the policy.
What is an Endowment Plan? – It is a combination of insurance and investment. The insured can obtain a lump sum over the additional premiums (if any) on the policy’s due date or in case of death.
What are Money Back Policies? – Provides life coverage throughout the life of the policy and therefore the benefits by maturity are paid in installments (at periodic intervals) by the survival benefits method.
What is the entire life insurance plan? – is a life insurance policy that is guaranteed to remain in force for the life of the insured. The sum insured is paid to the candidate of the insured in the event that the insured dies.
The common thing with these policies is that they provide bonds to the policyholder. The bonus can be obtained in traditional plans that are incorporated into the structure of the plan. These bonuses are of different types such as easy reversion bonus, adding loyalty, extra bonus final, etc. Therefore, traditional plans have 2 components, ie i) Life Cover & ii) investment component.
Traditional life insurance plan and premium amount
As mentioned above, an insurance provides protection against risks. You will get the risk coverage by paying an amount defined as Premium. In a very traditional life insurance plan, part of the premium is used for mortality charges (for life coverage) and the rest is invested mainly in debt or fixed income securities.
(What are the mortality charges? – The death rate is the amount charged each year by the insurance company to provide life coverage to the policyholder in the life of the insured.
Since these traditional plans have to pay BONUS to the insured, they have to charge beyond the “cost of insurance”. This may be the reason why endowment plans or money back plans are more costly than pure term insurance plans.
For example: Arun pays a premium of Rs 10,000 towards his life insurance to get the insured sum (life coverage) of Rs 1,00,000. Your life insurance company deducts a portion of this premium Rs 10,000 due to the “Cost of Insurance” or “Charge of Mortality“. This can be kept aside by your insurance company and maintains a “Life Fund”. This Life Fund is not invested anywhere. Insurance company uses this fund to pay death benefits.
Mortality burden is typically a bit very, say Rs 400 p.a. From the annual premium of Rs 10,000 that Arun paid for his life insurance. Of the remaining amount of Rs 9,600 (Rs 10,000 – Rs 600) varied expenses such as workplace administration, marketing expenses, policy maintenance, etc. are deducted and therefore the balance would be reversed
Why is the Traditional Life Insurance Plan a poor investment?
|Why is the Traditional Life Insurance Plan a poor investment?|
Traditional Life Insurance Plan – A Terrible Investment Option
High value insurance coverage and low life: As mentioned above, premium rates on traditional plans are much higher than term insurance plans. If you are purchasing an Endowment plan or a money back policy always covers, then keep in mind that you are paying a very high premium for low life coverage.
Low investment returns:
Conventional plans can be of 2 types – i) participating insurance plans and ii) non-participating insurance plans.
In the case of participation plans, the return on investment depends mainly on the bonds declared during the term of the policy by the life insurance company.
In the case of traditional non-participating plans, the expiration and death margins are clearly mentioned in advance.
That means that an insured knows what he / she is going to achieve in maturity or death.
In each case, most traditional life insurance plans provide investment returns of about 3 to 5.
Therefore, in terms of life coverage you pay high premium and you get low life coverage and in a similar time in terms of returns too, you get poor performance at maturity.
Percentage of returns are not guaranteed: Plans that fall within the “Participating Plans” class do not guarantee the percentage of returns. The bond rate declared by a life insurance company will vary from year to year. The product brochures clearly indicate that the rate of return is for illustrative purposes only. So, keep in mind this point.
Bonus terms and conditions: Bonuses such as the addition of loyalty or the final bonus may or may not be applicable in all traditional plans. They will be applicable based on the quantum of guaranteed sum and / or term of the policy.
No collating effect: The bonus (simple interest bonus) declared by most Endowment Plans or Money Back schemes is not made up. For example, let’s say your life insurance company declares a bonus of Rs 40 per 1000 insured sum for 2 consecutive years. If you have invested in an insured benefit plan Rs 1 lakh, when two years of policy you will receive a bonus of Rs 8,000 (Rs 4,000 + Rs 4,000). This Rs 8,000 would remain as Rs 8,000 until maturity of the endowment policy. It simply accumulates and the composition does not fit into the image.
High Penalty: If you decide to turn in a traditional life insurance plan within the initial years, you will end up paying a considerable penalty. You will give the policy for money only when the premiums have been paid for a minimum of 3 years of policy.
The tax savings is an additional benefit: The insurance is mainly for protection and not to save taxes. Keep in mind that saving tax is an added benefit, that’s all!
Erosion of wealth: Life insurance policies are long-term contracts. Once you are investing for the long term, do you prefer to get good returns adjusted for inflation or not? Your endowment or money-back plans are low-yield investments. These could offer you negative returns adjusted for inflation.
Do not blindly go through illustrations projected by your agents or advisors. A traditional policy may seem attractive these days when seeing the corpus of projected maturity. But, always inflation factor in the calculation. For example: you will be offered a maturity value of Rs 50 Lakhs in 20 years. On June 6, 1944, the inflation of today’s value will be reduced to Rs 15.6 Lakh.
Remember this simple point: “Any life insurance plan that pays cash before an insured dies is best avoided.” Otherwise, you will end up buying expensive and unwanted life insurance plans.
So who can buy these traditional life insurance plans? If you already have adequate life coverage, you want to safeguard your capital, and happy with a lower (or negative, inflation effect) in the long run, re-consider investing during a traditional life insurance plan. Even during this case is not an investment option, however, it is simply a long-term savings option!