Using insurance to plan your child's future

For parents who are convinced about the need to plan finances for their children's future but don't know how to do it, help is at hand. You have already read about the various child-related investment avenues available at the parent's disposal. One avenue that many parents are partial to is life insurance, i.e. child insurance plans. The reasons are not far to seek.

Child insurance is popular with parents for the following reasons:

It is a dependable route for parents to plan their children's future. Money back endowment plans for instance, tell the parent roughly how much he/she can expect and at what age (of the child) the money will be due.

Child insurance offers a lot of flexibility. There is something in it for all parents regardless of their risk appetites. Unit-linked child insurance plans (child ULIPs) have several options with varying equity components. Parents can select the one that suits their needs the most.

Let us bring each of these avenues under the scanner to see what they can do for parents anxious for their child's future.

Money back child insurance plans
Money back plans are ideal for parents planning for life stage events like child's education, marriage or seed capital for a business opportunity. Ideally, parents would have to set aside money separately for each event and plan their finances accordingly. A money back insurance plan allows them to combine their planning for all these events in a single avenue. We can understand this better with an illustration.

A father wants to set aside some money for his 5-year old daughter's higher education. He also wants to have enough money for her marriage a few years after that. This is the ideal scenario for a money back plan.

The father can select a money back endowment plan with a 20-Yr tenure for a sum assured of Rs 10 lakhs (Rs 1 million). The annual premium that he will have to pay is Rs 67,175 (refer Table 1). The premium amount will vary across life insurers.

In case of an eventuality to the parent, his nominee will receive the sum assured of Rs 10 lakhs plus bonuses accumulated till that period. In case of survival, the parent will receive disbursements over four regular intervals according to a pre-determined schedule (refer Table 2).

Money back insurance plans are essentially variants of endowment plans, which give you a lumpsum payment at maturity. While endowment plans also serve the purpose of helping parents save for the child's future, they aren't as flexible as money back plans. For instance, in our illustration where the father has multiple objectives (daughter's education and marriage), an endowment plan with a single disbursement may not be as helpful as a money back plan with multiple disbursements.

ULIPs
If parents are pleased with money back plans, then ULIPs should thrill them. As far as flexibility goes, it does not get any more flexible than a ULIP. ULIPs differ from conventional insurance in the way they invest your premiums. Unlike endowment plans that invest primarily in government securities and corporate bonds (as specified by the regulator), ULIPs can also invest in equities. Below, we have outlined some of the key features in a ULIP.

As an investor, you can decide how much your ULIPs must invest in equities and debt. For this ULIPs offer a range of options with varying equity and debt components. As an investor you can choose the option based on your risk appetite.

However, unlike conventional endowment plans, ULIPs do not guarantee a return, although your sum assured is guaranteed provided you have paid the minimum premiums (even conventional plans no longer assure a return). This is because ULIPs invest in equity and debt markets and offer market-linked returns. Your returns will fluctuate in line with the ULIP's performance.

We mentioned that ULIPs are flexible. Their flexibility is evident in two features. One, they allow individuals to switch across options. For instance, as a parent you can afford to have more equity at an early stage of your investment plan for your child's education. As your plan nears the end of its tenure, you can shift your monies to a debt option. Most insurers allow for a predetermined number of free switches across ULIP options every year.

The second feature that makes ULIPs flexible is that they allow for a larger number of withdrawals. In the money back illustration, there were four disbursements with a bonus disbursement at the end of the tenure. In a ULIP you can make many more withdrawals over the tenure of the plan; in fact some ULIPs permit multiple withdrawals every year.

ULIP expenses are usually lower than those of conventional endowment plans. Over the long-term, this reflects in the returns of the ULIP.

Our view on ULIPs

There is little doubt that if selected prudently, ULIPs can add considerable value to the portfolio you wish to build for your child's future. Equities are well-placed to give a boost to your child portfolio's over 15-20 years. They can also help you go one up on inflation. These are facts established by several studies.

However, the ULIP frenzy has made investors including parents ignore the prudent principles of financial planning. We are certain that parents with unduly high investments in Aggressive ULIPs (which can invest upto 100% in equities) would be concerned with the sharp drop in their child's portfolio every time the market crashes. So going overboard in Aggressive ULIPs could make your child's portfolio swing like a pendulum during stock market volatility, which is something you do not want.

The answer is in striking a balance between equities and debt, because during stock market volatility, debt can be a major ally. It is best for parents to go for a ULIP with moderate equity investments (balanced option), as opposed to a ULIP with a heavy equity allocation (aggressive option).

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