How to choose a traditional insurance plan

The traditional insurance plan is complex and difficult to understand when compared to the ULIP. In this article, we will discuss the important points that need to be looked before choosing a traditional insurance plan.

The investors' choice for insurance keeps on shifting from a regular/traditional plan to popular/ULIP or vice-versa depending on the financial market condition. The growing equity market always attracts more ULIP-based investors whereas troubled domestic and global economic condition shifts more investment towards traditional insurance plans.

As the world is experiencing a major economic slowdown and uncertainty is shaking the equity market the time has come back to look towards the traditional insurance plan for investment. Compared to a ULIP plan where returns are based on equity market performance, a traditional insurance plan is based on the system of how much you pay and what you get.

Amit Sethi is an MBA (Fin) graduate. He has spent 8 years in Equity research and Stock broking sector. He can be reached at amvilube@gmail.com

Here are four points to ponder over:

1. What you have to pay and for what return?

The investor should, first of all, categorise the policy based on guaranteed return or the sum assured, and the total premium required to be paid to achieve such return for a given period. The categorisation of policy based on payment-and-return matrix gives an idea about cost associated with it.

To get an idea let's check an example of a 20-year endowment policy for a 30-year-old investor with a guaranteed return of Rs 10 lakh and an annual premium of Rs 46,900. The guaranteed return here is amount assured whereas a non-guaranteed return depends on the bonus which is decided by the insurance company.

To compare, check the term plan for similar return and equivalent term, which should be around Rs 2,000 to Rs 2,100 per annum. Hence, the investor has to pay Rs 44,900 in addition, to ensure the return on maturity. In short if we check the actual return for a guaranteed plan by using a financial calculator, then actual return on investment would be just around 0.67%.

2. Check for extra benefits associated with policy

When it comes to breaking of illusions related to guaranteed return the insurance agents would always bring the discussion to bonuses paid under a policy. There are three types of insurance bonuses, i.e., cash, reversionary and terminal.

In the long run, the insurance companies declare bonuses based on interest rate, inflation and surplus earned by that policy. So it is very difficult to ascertain the benefits of bonuses for any policy. As the bonus is declared by a company, it becomes guaranteed, and if it is taken as cash then it is called cash bonus and if added to policy as sum assured then it becomes a reversionary bonus.

The reversionary bonus can be simple and compounded. The investor should always try and opt for a compounded reversionary bonus.

A bonus which is paid only at the end is called terminal bonus. The investor should always assess its requirement for liquidity and need before deciding for bonus system. Bonus rates declared in the past should also be checked once before selecting a policy.

3. Check the non-timely surrender value of policy

Sometimes policy cannot be continued due to unavoidable circumstances. The investor must consider such a situation in advance before selecting an insurance policy. In a traditional insurance plan, the company adjusts its cost during initial three years so most of the companies don't allow any surrender value if policy is discontinued before it.

After three years the surrender value is allowed on most of the traditional insurance policies. The surrender value is paid in two ways: guaranteed and non-guaranteed surrender value.

As per government regulations, the insurance companies are required to declare the minimum guaranteed amount as surrender value after completion of three years. For non-guaranteed surrender value all the components of insurance are considered for payment calculation such as assured return, bonus, premium paid, etc. Some companies also offer the higher surrender value between the two.

4. Impact of untimely premium payments

The impact of untimely premium payment must be considered before selecting a plan. If the premium is not paid before three years of policy completion, then the complete policy will lapse. However, after three years the insurer may get a reduced amount of the sum insured or the policy term can be extended or the policy can be resumed after paying some penalty. It all depends on the policy, and insurance companies offer.

Since most of the traditional insurance plan is for long tenures and any mistake in selection of policy cannot be reversed due care and precaution should be taken before finalising the policy.

To conclude, we can say that flexibility, return, risk cover, and liquidity are some of the important criteria to select the good insurance plan.