Buying a life insurance policy is not easy. A typical life insurance product comes with a complex construct and many caveats. Poor disclosures in policy brochures and benefit illustrations only compound the confusion. So, if you are planning to buy a life insurance policy, it’s important to know at least the basic features so that you are able to understand your policy better.
To help you do this, here are the four most important aspects that one must understand and know when buying a life insurance policy.
Types of policies
Knowing this is a must because different types of insurance policies function in different ways. In your rush to save on taxes, you often end up buying bundled plans with very little idea of how they actually work. Here is a brief description of what you will typically find in the market.
Start with understanding the plain vanilla term insurance policy. The premium that you pay for such policies only charges you for the insurance cover. So, if the policyholder dies during the policy term, the nominee gets the sum assured or the insurance money, and if she survives the policy term, she does not get anything back.
A term plan is a must if you have dependants. This is not only the cheapest but also the simplest type of policy to understand and deal with.
In other types of policies, insurance companies bundle an investment component. These can be broadly divided into two segments: traditional and unit-linked insurance plans (Ulips). Traditional policies have opaque structures, which means that they do not disclose the embedded costs or the investment portfolio. However, they come with some guaranteed benefits, which can be further sliced into two categories: non-participating and participating plans.
A non-participating plan will guarantee the maturity amount upfront thereby guaranteeing investment returns when you buy the policy. A participating plan will guarantee only a minimum amount, usually the sum assured. The additional benefits are then pegged to the performance of the participating fund and are declared in the form of bonuses.
These policies invest primarily in debt products. Since you don’t know the costs, you need to look at the illustrations carefully. In the case of a non-participating plan, even as the construct lends to a quick calculation and disclosure of the net return on investment, insurers don’t disclose this and regulations don’t mandate such disclosures either. Therefore, you need to sit with a financial adviser or take the help of online calculators to calculate the net return from the benefit illustration.
But for a participating plan, the returns are variable. The benefit illustration will mention the post-cost maturity corpus at an assumed rate of investment of 4% and 8%. Again, the investment benefits are mentioned in absolute terms and the post-cost returns or the net return is not disclosed. You have to look at the net return because it makes comparison easier and also gives you a sense of costs. According to insurers, traditional plans typically return in the range of 3-6%. Compare this with other products such as Public Provident Fund (PPF), which gives a much higher rate—8.1% at present—before you make a decision.
Coming to Ulips, these are transparent, bundled products that invest your money in the markets. Product regulations have made Ulips competitive in terms of costs as well, but keep in mind that if you looking for insurance, Ulips are not the best option.
