A to Z of Life Insurance

Who should buy life insurance?

If you have anyone who relies on you for their expenses, you should buy life insurance. That is, if you have any dependent, you should buy life insurance.

The dependent(s) can be your parents, spouse, kids - anyone who can be in trouble financially if you are not around.

Types of Life Insurance Policies

There are three popular forms of life insurance policies:

1.     Endowment Plans

2.     Unit Linked Insurance Plans (ULIPs)

3.     Term Insurance Plans

Let's discuss each in detail.

Endowment Plan

In Endowment plans, the premium paid is partly used to secure insurance for your life, and partly used for investments to generate returns. Thus, this is insurance plus investment type of a plan.

Endowment plans were the most popular plans till some years back. This was largely because there were very few other options, and because the returns were assured by the insurance company.

The insurance company generally invests the money in virtually risk-free government debt - which is very safe, but earns meager returns. Each year, the company declares a "bonus", which is nothing but the profit on the investments less the administrative and other expenses of the company.

In case you survive the tenure of the policy, an amount equal to the sum insured plus the accumulated bonuses is paid to you. If you expire during the tenure of the policy, the sum insured plus the accumulated bonuses is paid to the nominee. 

The investments made by the insurance company are absolutely non-transparent. You have absolutely no control over the investment made by the company. In fact, you would not even know how much money is invested in which asset!

The bonuses declared are not very transparent as well - you don't know how much the company has earned, and you don't know how much the administrative and other expenses of the company are! 

Therefore, for people seeking insurance as well as investment in the same product, ULIPs have become very popular.

Unit Linked Insurance Plan (ULIP)

It is a type of insurance, in which your premium amount is dived into two parts.

• One part, a small fraction of your premium, is used to provide you insurance.
• The other part, the much larger portion, is used to buy "units" of investment.

The first part (insurance part) depends on the sum insured - the higher the sum insured, the more is the money spent to buy insurance.

The money from the other part (investment part) is invested based on the type of the units - it can be largely in equities, or only in debt, and all the flavours in-between. The value of these units increases depending on the returns these investments provide.

At any time, the sum insured is either the original sum insured that you chose at the time of buying insurance, or the NAV of all your units - whichever is higher. 

Advantages of ULIP over Endowment Plan

A ULIP provides you much more control over where your money is invested - You decide which kind of units to buy - they can be largely for stocks, for debt, or a combination of both. 

Also, you can switch between different units - usually a couple of times a year, depending on your insurance company. This means that depending on your analysis, you can move from stocks to debt to a hybrid investment - whichever way you want. 

This compares very favourably to endowment plans, where you have absolutely no control over where your money is invested. 

Another big advantage of ULIPs is that after a couple of years of buying the plan, even if you are unable to pay the premiums, the insurance cover continues. When you don't pay the premium, the insurance company sells some units to get an amount so that it can continue to provide the life cover for you! 

But in spite of it being better than endowment plans, ULIPs too are similar to them in one aspect: they provide insurance and investment.

What if someone wants just insurance - which is the correct way to buy insurance anyway? The answer is: Term insurance.

 

Term Insurance Plan

When you buy insurance for your car, or your home, do you expect any return on that "investment"? Do you expect that if the car doesn't meet with any accident, you would get the money plus some interest on it back at the end of the year? 

Of course not! Then, why should we expect our Life Insurance to pay us back, and in turn pay a lot more for insurance than it actually costs? Should we not buy "pure" insurance, like we do for our car or home? 

Yes - that is exactly what we should do! We should understand that insurance and investments are different, and they need to be treated differently. 

For life insurance, you need to calculate an amount that your dependents would need, so that they can lead a normal life out of the returns generated from it. This amount should be the "Sum Insured" when you buy a life insurance policy, and it should be a risk-only policy. 

Term Insurance provides such a pure, risk-only cover for your life. It is a type of insurance where your premium amount is used only to buy insurance for you - just like car or home insurance.

Since the premium amount is used only for insurance, the biggest benefit of a term insurance policy is that it provides life insurance at the lowest possible price. This means that the money saved can be invested in other avenues to fulfill other goals, while still enjoying the benefit of adequate insurance!