Last week we analysed LIC's Jeevan Aastha and ascertained that the maximum and minimum return from the policy, depending upon the age of the policy holder, would be in the range of 4.69 per cent to 7.32 per cent per annum (p.a.)
Subsequently, several readers wrote in requesting an analysis or at least a
view on a particular policy of their choice that they had identified. Not surprisingly,
all such policies were either ULIPs or endowment related plans. Therefore, instead
of replying to each person individually, we thought it would be best if we address
this issue through our column.
We have often pointed out and will do so once more - we are not in favour of any plan from whichever insurance company that seeks to combine insurance and investment. Such a blend, without exception, tends to be sub-optimal. It is always better to keep insurance and investments separate. All endowment, whole life policies and ULIPs are examples of combination insurance plans.
On the other hand, a term insurance plan has no cash payout at the end of the
term. This means if the policyholder were to pass away during the term of the
policy, his family will get the sum assured.
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However, were he to survive he will not get a single rupee. In other words,
term cover is pure life insurance and has no cash or surrender value. If this
is indeed the case, why do we favour term insurance as against a traditional
endowment or whole life policy which, at least pays, at the end of the day,
no matter what, either the sum assured or the maturity value? This then is the
subject matter of this week's article.
Basically insurance is a cost. It is a contract (policy) in which you purchase
financial protection or reimbursement against a loss or an unanticipated expense.
The price paid to purchase such protection is also called premium in insurance parlance. Such premium is payable, year-in-year-out, till you desire protection from the loss. Now, take for instance car insurance. You pay the insurance premium, year-in-year-out, to protect yourself against the financial damage that an accident can cause.
If you are a safe driver and manage not to bang your car during the year, the
premium paid is wasted - you don't get anything out of it. And you are perfectly
happy to have done so, so long as you and your car are safe.
Take medical insurance. Again, premium is paid to defray any costs of medical
emergencies or hospitalisation. However, if you remain fit and healthy the premium
paid on buying the medical insurance is lost. But then again, you do not mind
this do you? Then why should life insurance be any different? But it is. It
always has been.
The reason for this is mainly because life insurance premiums come bundled with the pure premium part combined with the part that gets invested on your behalf. The policy is sold more as an investment where the insurance just comes along.
However, know that insurance never comes along, it always has to be paid for.
In the case of life insurance, the premium is known as morality premium. Such
mortality premium is applicable for all polices, year after year, without any
exception, till such time that the life is insured.
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Even in the case of single premium plans or policies where the premium is payable only for part of the policy term, nonetheless, the mortality premium keeps getting deducted every year from the fund value. So once gain, insurance never comes along, you actually buy it, year after year.
Let's take an example to further understand this concept. Take the case of a 30-year-old person who desires to buy an insurance cover of Rs 10 lakh. Were he to buy an endowment plan, the premium that he would pay is around Rs 39,000 per annum.
However, a term plan would just cost Rs 3,800 per annum for the same amount
of risk cover of Rs 10 lakh. The difference between Rs 39,000 and the pure risk
cover cost of Rs 3,800 is the investment premium.
Putting it differently, for a premium of Rs 23,000 per annum, one can either
purchase an endowment plan where the sum assured is Rs 6 lakh or on can buy
a term plan where the sum assured is Rs 60 lakh. Your choice.
Of course, brokers earn a far greater commission if they sell you whole life
policies than if they sell you term cover. And the logical sounding argument
given against buying a term cover is why opt for the same when you don't get
anything back in the end? But now hopefully you know better.
And before we end, to answer all those who wrote in. We do actually have a
favourite policy. It's called "Buy term and invest the difference"
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