Insurance buyer

ONE TOO MANY

Most insurers give you the option of paying your premiums yearly, half-yearly or quarterly; the premiums are structured in a manner that it pays for you to choose the annual payment option, even given the opportunity cost of paying your entire year’s premium at the start of the year. Typically, what you pay in the half-yearly premium option is a little more than half of what you pay in the yearly option; effectively, by opting for yearly payment on a Rs 10 lakh Kotak Term Plan over 20 years, you save Rs 1,480 over the tenure vis-a-vis the half-yearly option and Rs 2,960 over the tenure vis-a-vis the quarterly option. (Note: all the illustrations cited here apply to most covers from private insurers; premiums may vary marginally.)

Likewise, if you are considering buying two policies of the same type in a particular year, reconsider: instead, buying a single policy for a higher sum assured will lower your premium considerably. Typically, the premium payable per Rs 1,000 sum assured comes down with an increase in the sum assured. Illustratively, the cumulative premium on two endowment plans–one for Rs 5 lakh and the other for Rs 1 lakh–is Rs 27,256; the premium on a single cover for Rs 6 lakh is marginally lower, at Rs 26,926. Your saving: Rs 330 a year, or Rs 6,600 over 20 years.

EASY RIDERS

A level term cover rider (that is, an add-on to a base policy) lets you increase your life cover on plans other than term plans, up to the sum assured of the base policy. It offers you pure risk cover at the least cost, even less than a conventional term plan. Attaching a term plan rider to a base endowment plan–rather than buying a separate term cover and an endowment plan–you can save significant amounts in premium. The same principle applies when you want to attach a health cover rider to a base policy, rather than buy a separate Mediclaim cover. Whereas the premium on a Mediclaim cover goes up with age, the premium on a health plan rider is fixed throughout the policy tenure.

By attaching a Rs 6 lakh term plan rider and a Rs 3 lakh critical illness rider to a Rs 6 lakh base endowment plan (rather than going in for a Rs 6 lakh endowment plan, a Rs 6lakh term plan and a Rs 3 lakh health insurance policy), you save Rs 2,760 a year in premium; over 20 years, this adds up to Rs 55,200.

EARLY AND JUST ENOUGH

Buying insurance when you’re young lowers your premium. Also, if you take cover when you’re young and healthy, insurers typically don’t insist on a medical examination–unless you want an extremely big cover. The same’s the case with health insurance; for a Rs 2 lakh health cover from Bajaj Allianz, a 25-year-old would pay Rs 1,948 a year as premium; at age 45, the cover will cost you Rs 2,565 a year (saving of Rs 617). But, more important, by insuring early, you establish a good health history and won’t have to undergo medical examinations–with the attendant risk of higher premiums–when you step up your cover. Also, if you don’t make any claim and make the premium payments on time, you will qualify for a no-claims bonus in the form of additional cover. Without paying any additional premium you can enhance your cover to over Rs 5 lakh. That is, at age 45, you’ll pay Rs 2,565 as premium. On the other hand, if you were to buy a Rs 5 lakh cover at age 45, you’d pay Rs 5,700. That’s a saving of at least Rs 3,135 a year.

STRENGTH IN NUMBERS

When you buy householder’s insurance–which covers risks under ten different heads–you can get a 15 per cent discount on the premium if you take cover under four to six sections; you get a higher discount (20 per cent) if the cover is for more than six sections. By taking just the essential covers (fire and allied perils; burglary; electronic appliances, including television), you can save Rs 442.50 a year in premium.

When you buy health insurance for yourself and your family members, you get a 10 per cent discount on the premium outgo. For instance, if you’re aged 30 and your wife is 25, and you both decide to take a Rs 1 lakh health cover from any of the PSU firms, you save Rs 247.20 a year in premium. Over 20 years, that’s a saving of about Rs 5,000.

TALL CLAIMS

When you buy a new car after selling an old one on which you’ve made no motor insurance claim over the years, you can lower your premium by transferring the no-claim bonus to your new car. On a new Maruti Zen, you’d normally pay a premium of Rs 11,260. But by transferring a 50 per cent no-claim bonus (which you’d be entitled to if you had had made no claim for the previous five years), you’ll effectively pay only Rs 5,630. The savings get much better when you upgrade to a luxury segment. Illustratively, on a new Chevrolet Optra, you’d normally pay about Rs 35,000 as premium; by transferring a 50 per cent no-claim bonus, you pay only about Rs 17,500.

Additionally, if you’re a member of an automobile association, you get a 5 per cent discount on the premium on the ‘own damage’ component, subject to a ceiling of Rs 200. There is an additional discount of 2.5 per cent on the premium amount, capped at Rs 500, if you’ve installed an anti-theft device certified by the AAAI.

SHARE THE BURDEN

A ‘deductible’ is that portion of your motor accident insurance claim that you’re willing to bear on your own. For instance, if you opt for a deductible of Rs 1,000 on your motor insurance, it means that for accident claims under Rs 1,000, the insurer will pay nothing; and if the claim amount exceeds Rs 1,000, the insurer will pay only the amount in excess of that. Why would you not make a claim? Because you can benefit to a greater extent from a no-claims bonus–on the same car or even a new one.

Say you’re paying a premium of Rs 5,000 on your car (third-party: Rs 700, occupants: Rs 225, own damage: Rs 4,025), with a no-claim bonus of 50 per cent and a deductible of Rs 500. If you make a claim for a small sum this year, you stand to forfeit 50 per cent of the own damage premium (or Rs 2,012) next year.

Your money, your life

What does life insurance mean to you–a tax saving instrument, forced savings, or a cushion for your financial dependents? Probably one of these. So far, Indians have not had any reason to seriously consider insurance as an investment product. But that outlook is set to change. Already, thanks to the tax treatment of insurance premiums,in-surance is now considered on a par with such instruments as ELSS (equity-linked savings schemes), provident funds, NSC and pension plans. But while the section 80C limit has upped the tax-free limit for life insurance from Rs 70,000 to Rs 1lakh, it has made life complex for insurers, who have just begun to pat themselves on the back for the success of the immensely popular unit-linked insurance schemes.

The new dispensation. So far, Section 88 provided for a tax deduction of only 15-20 per cent, depending on your gross income. This limit has now gone up to 30 per cent. Says Stuart Purdy, managing director, Aviva Life Insurance: "The benefit now is spread to even those earning more than Rs 5lakh, something that Section 88 did not offer." Is this good enough reason to buy insurance? Some experts are categorically opposed to the idea of insurance being used as a tax-saving instrument. Says NaniJaveri, chief executive officer, Birla Sun Life Insurance, "Insurance is bought on a need-based analysis and not on the basis of tax benefits they offer. The tax advantage is a side benefit".

Yes, insurance must be bought based on need, but given that most insurance companies today peg their products with other instruments, it makes sense to look at returns as well. And, thanks to the newly-introduced Section 80C, the tax treatment is the same across a range of products, which means that at some level you will have to consider insurance as one more investment product.

The industry is not happy about this state of affairs.Ana-lysts say that the new tax implications will spell the end of pension products. So far, investment of up to Rs 10,000 in pension products qualified for a deduction under Section 80CCC. This has now been clubbed with other products under Section 80C, impacting the popularity of these products. SaysN.S. Kannan, executive director, ICICI Prudential Life Insurance: "There is data to show that there is an overwhelming need for pension products, the doing away of this benefit may keep many away from pension products."

The year ahead. Since they can’t do much about the tax situation, insurers are waiting for the setting up of the pension fund regulatory authority and the passage of the Pensions Bill. "Once the modalities of the pension regulations are in place, one can expect a lot of activity in this area and products coming from insurers," says BimalBalasingham, director, Tata-AIG Life Insurance (see box: Pension Roulette).

While insurance companies have been offering pension products for some time now, the bill will enable the pension funds authority to get its act together and draw up plans for how this sector will function and what role insurers will play. "Globally, insurers work closely on pension products and it will be a role that we will play here as well. Pension products offer immense potential" saysKannan.

Insurers also hope that 2006 will see the IRDA (Insurance Regulatory and Development Authority) release the ULIP (unit-linked insurance plan) guidelines. These will change the way these plans are currently being sold. Also, insurers and customers will be able to get some clarity on the investment to sum assured ratio, as well as the new tax implications. Currently, you get Section 80C benefits on the entire amount you contribute into theULIP, up to a maximum of Rs 1 lakh. However, the ULIP guidelines are likely to change the rules of the game, with the sum assured being defined in multiples of the premium that you pay to get the full Section 80C benefit. What this means is that if you park Rs 1 lakh premium in a ULIP to benefit from Section 80C, you need a minimum of Rs 10 lakh sum assured insurance cover. Otherwise, you will gain only proportionately on the premium contribution equivalent to the sum assured you opt for.

Distribution channels. The industry is looking forward to guidelines governingbancassurance. This will enable some product customisation and value-addition on those products routed through this distribution channel. The current regulation ties a bank to a specific insurer and limits the bank’s customers’ choice. This is likely to go away since the market is mature enough today to handle multiple insurance products from the same bank. "In its current form, bancassurance is working well, but any change in the model should be looked into for the benefit that it will offer the customer," says Purdy.

The advent of insurance brokers has added yet another distribution channel for insurers. "The broker brings his expertise in suggesting the best policy (from all insurers) that will fit the client. Such a service goes a long way in providing the best product fit," says Birla Sun Life’sJaveri. The broker also helps in product development by sharing customer needs with insurers. The insurance distribution arms would also reap the benefits of synergies from a combined life and non-life product. "Bundling of life and non-life insurance products will reduce costs and offer greater value," saysBalasingham.

And what about the returns that policies such as ULIP will offer? Most insurers refuse to speculate here. SaysJaveri: "It would be difficult to hazard a guess on returns. Our investment philosophy is long-term and we endeavour to maximise returns for our policyholders at an optimal level of risk." He is not alone. Kannan recommends policyholders look at their insurance needs to chose a product with the right risk mix, and not buy insurance for the returns. But customers are keen on returns from any investment, and will look at ULIPs to make healthy profits in line with equity market returns.

Policy changes. A major issue to affect insurers and customers alike is the implementation of the EET regime (exempt on contribution, exempt on interest earned and taxed on maturity). Kannan says: "There will be opportunities todeve-lop products that best capitalise on the policy changes. But one will have to see how it fits into one’s insurance needs."

Customers can expect better service and a new product range, especially if the government ups permissible FDI (foreign direct investment) limit from the current 26 per cent. "

ELSS vs single premium ULIPs

Single premium, unit-linked insurance plans (SP Ulips) from life insurers have been the preferred flavour for a lot of people who ‘invest through insurance’. Their main draw is the tax break under Section 80C of the Income tax Act, 1961. For many, they have filled the void left by the Life Insurance Corporation’s popular fixed-return, single-premium plan, Bima Nivesh.

However, there have been quite a few additions to the universe of financial instruments in recent times, and equity-linked savings schemes (ELSS) are one of them. They, too, give tax breaks and allow lump sum investment. So how do they stack up against SP Ulips?

The Ulip option. A Ulip packages a life cover with investment in units similar to mutual funds (MFs). So, while part of your premium pays the administration charge, the rest is invested in assets like equities or debt, depending on your choice.

Going by the way you pay your premiums, Ulips can be of two types. The first is the regular premium paying option, where you pay a fixed amount every year (monthly, quarterly, half-yearly or annually) for at least the first three years of the policy. The second is the SP Ulip, where you have to pay a lump sum just once.

If you choose the regular premium option, in the first three years, the cost you have to bear is about 60 per cent of the premium you pay. Alternatively, if you buy SP Ulips for three consecutive years, it would cost you around 10 per cent of the premium you pay every year. So, the SP Ulip is the obvious choice among the two.

The ELSS option. An ELSS is a diversified equity mutual fund scheme. You can make a one-time investment.

The similarities. For both SP Ulips and ELSS, you have to invest once and the investment is locked in for three years. Under the present tax laws, what you get on maturity is tax-free. While in ELSS your entire investment will be in equity, SP Ulips give you the choice of investing in equity or debt instruments, or both, and the choice to move from one to the other.

The differences. The biggest difference is that SP Ulips give you a life cover, while ELSS does not. So the ‘mortality cost’ of insuring your life is deducted from the value of the fund every month. When the plan matures, the value of the units, or fund value, is yours. If a policyholder dies during the plan term, the higher of sum assured or fund value is paid to the beneficiary. However, some plans like Met Smart Premier of MetLife Insurance and Bajaj Allianz UnitGain Guarantee SP pay out both, albeit at a higher cost.

The tax laws. According to the Insurance Regulatory and Development Authority (Irda), the life cover of a SP Ulip has to be at least 125 per cent of the premium. But under I-T rules, if the premium paid for a policy is more than 20 per cent of the sum assured in a year, then deduction from taxable income will be allowed only up to 20 per cent of the sum assured. In other words, to get the entire premium deducted from taxable income under Section 80C, make sure the cover is at least five times the premium.

The costs. In an ELSS, the amount invested is subjected to only two charges. One is the entry cost or the load, which is normally 2.25 per cent of the amount invested. After the units are allotted, there are recurring charges also called the expense ratio. For ELSS, the average is around 2.25 per cent of the fund value, while the maximum permitted is 2.5 per cent.

For SP Ulips, first there is the premium allocation charge. Akin to the entry load for an ELSS, it ranges from 2 to 4.5 per cent for amounts below Rs 1 lakh, and goes down for higher amounts. Then there is fund management cost, which is similar to the MF recurring expense ratio.

Further, there is the mortality cost, which is based on the difference between the sum assured and the value of the fund. Some SP Ulips also carry a ‘surrender charge’ for exiting the plan in the fourth and fifth years as well. Then there is the ‘policy administration charge’. It is deducted from the fund value either as a percentage, a fixed sum every month, often based on the sum assured.

Irrespective of how the charges come in, the post-charges returns from most SP Ulips is below that from the ELSS funds for lower amounts. Lower front-end costs often come with higher mortality rates and policy administration charges, and so on.

The returns. Since both SP Ulips and ELSS have a three-year lock in, to compare them, one should look at their three-year returns. However, since many of the SP Ulips have been operating for less than three years, we have considered their last one-year performance.

Of the 29 open-ended ELSS plans in the market today, the average return as on 16 April 2007 has been 3.90 per cent over the last one-year. Funds like Can Equity Tax Saver and Prudential ICICI Tax Plan have delivered negative returns of 21.89 per cent and 8.64 per cent, respectively, against the Sensex return of 18.74 per cent during the same period. While none has managed to beat the benchmark Sensex, six funds have managed double-digit returns with Fidelity Tax Advantage delivering highest return of 18.03 per cent.

The 10 SP Ulip plans in operation for the last year have given average returns of 12.2 per cent. While none of them have given a negative return, individual returns are between 6.55 per cent and 15.01 per cent. Over five years, the benchmark Sensex has given returns of 32.01 per cent and out of 17 ELSS funds in existence since five years, only four have underperformed the Sensex. The SBI Magnum Tax Gain Scheme 93 has delivered a compounded annualised return of 55.10 per cent. Meanwhile, ICICI Prudential’s Life Link, a SP Ulip, an early entrant, has just managed to beat the benchmark by delivering compounded annualised return of 32.92 per cent over the same five-year period.

The decision. Given the cost structures and the return rates over the last few years, ELSS emerges as the better option if you are looking purely at saving taxes through investment. (In fact, if you need insurance you can buy a pure term life cover, which is usually quite cheap.)

Costs in the MF industry are standardised, but not in insurance. So, for SP Ulips, there are more charges and different companies factor them in differently. So it is tougher to compare the nature of their impact on the investible part of your premium. Eventually, the price of a SP Ulip works out higher than ELSS.

But then, all ELSS schemes do not perform equally well. So you will have to choose based on factors like risk-adjusted returns. (See: Best Funds 2007, 30 April).

An SP Ulip may make sense in the longer term, as the costs are front-loaded. It may make sense for larger amounts, too, since there would be no entry costs in most cases.

But purely to save taxes, that, by implication, limits investments to Rs 1 lakh, ELSS will be the way to go till SP Ulips standardise and reduce their costs.

Traditional Plans

What Are Traditional Policies?
Traditional insurance policies invest largely in debt products. They characteristically do not invest in equity, unlike unit-linked insurance plans, and are less transparent than the latter. The cover that they provide is much more expensive than term plans. The cost of the cover, the mortality premium, does not vary much from one traditional policy to another. Endowment, money-back and whole-life plans form the basket of traditional policies.

Endowment
Here, a part of the premium is invested in instruments specified by the insurance regulator. The returns, declared every year as bonus, are reinvested as guaranteed additions. On maturity, the policyholder gets the sum assured (SA) plus the bonuses. Typically, the SA is guaranteed on maturity. On death, the SAa plus the bonuses accrued are paid to the nominee.

Money-back
In these policies, the returns on investments made in the form of premiums are periodically paid to the investor over the term of the policy. On death, while some polices pay the SA and bonus additions without deducting the payouts, others deduct the amount paid.

Whole-life
This plan gives cover for the entire life of the insured. Premium has to be paid for a specified term, often till the insured reaches the age of 80-100 years. Depending on the policy, it could run till you are anywhere between 80 years and 100 years old. On maturity, the insured can either terminate his policy and receive maturity benefits—SA and bonuses declared by the insurer—or continue the cover for the rest of his life without paying any premium. On death, the nominee gets the SA plus bonuses accrued. The wealth that this plan is primarily meant to create can be bequeathed by the insured to his heir. As the insurance risk is spread over a long term, whole-life plans are the second cheapest in the basket of insurance policies after term plans.

Term Plan

What Is A Term Plan?
It is the simplest and most basic type of life insurance policy. The contract signed between the insurer and the insured says that while the insured will pay a premium, his nominee will be paid a sum of money if he dies during the term of the policy. There is no provision for the insured to save and, hence, he does not get any money back at the end of the term. Since a term plan only involves risk cover, it gives protection at the cheapest cost.

How Can I Pay Premiums?
Premiums can be paid either as a lump sum (the single premium mode) or at regular intervals. The regular premium can be paid annually, quarterly or every month. The regular premium remains the same throughout the term.

Can Get My Premiums Back?
In a term plan, the insured does not get any money at the end of the policy term. Premiums are returned on maturity in ‘return of premium’ policies, which have higher premiums.

How Should The Sum Assured And Term Be Chosen?
As the sum assured is expected to take financial care of the insured’s dependents if the need arises, it should depend entirely on the financial liabilities of the insured. The cover should ideally be around six times the annual income of the insured and take care of liabilities like loans. For the insurer, the income and health of the buyer determine the amount of cover it can offer. Insurers usually offer 20 times the annual income of the insured as cover. The insured may be asked to take a medical test if he wants a higher cover. Iif the insured buys the cover, the insurer pays for the test. the insured refuses the cover, he has pay for the test. The term should depend on the age of the buyer. Ideally, the cover should be available till the insured retires or till he anticipates his dependents would be capable of fulfilling their financial needs. generally provide terms of anywhere between five and 30 years.

Insurance

Those well informed about insurance will tell you: “Insurance is sold, not bought.” For the lay Indian customer today, it is a reality that bites hard. How does he make sense of the information that comes out of the loud din of sales pitches? Long used to limited insurance offerings by public sector monopoly players, the opening up of the insurance sector seven years back has exposed him to a deluge of new and, in many cases, complicated products. Every insurance agent tells him that his company’s policy is the best. How does he figure out the best insurance covers for himself? With awareness about insurance itself still low and in the absence of objective, affordable and quality advisory services, the buyer has to pretty much fend for himself in this jungle. It is in this backdrop that in this special issue on insurance, we begin an annual feature of providing information about the best insurance policies. This latest effort is in line with our endeavour to set the reforms agenda in the space of personal finance to help our readers.

Many of us know that term life insurance plans provide life cover at the lowest cost. In this issue, we tell you how they work and how to buy them. Most importantly, we list the plans with the lowest premiums. While term plans have the virtue of minimising your premium obligations even as your family is ensconced in a large life cover, there are many who, for reasons ranging from dearth of time to lesser familiarity with investment products, prefer to use life insurance as an investment tool too. The recent past has seen numerous launches of unit-linked plans (Ulips) that offer transparency, flexibility and growth possibilities and have become popular. How do you find out which Ulips are the best? In this issue, we present the findings of our path-breaking research to rank a major category of Ulips, an exercise we hope to expand in the future to cover all Ulips. We tell you how to buy the best pension and kids’ Ulips and give essential information on their returns and costs.