Ever wondered why most of us end up paying insurance premiums in the last few months (January to March) of each financial year. Well, that's because, insurance polices are often bought during that time span i.e. when the tax-planning 'season' is at its peak.
The trouble with such an approach is that tax-planning becomes the cornerstone for buying insurance and the 'insurance' aspect is sidelined. Sure, tax-planning is an important factor (premiums paid towards life insurance policies are eligible for deduction under Section 80C of the Income Tax Act), however, it should never be the mainstay. While doing so, the individual could well land up with the wrong insurance policy.
The right approach to buying insurance is to evaluate one's insurance needs and then narrow down on the most appropriate policy type. Given that there are multiple players in the life insurance segment, choosing the right insurer is vital as well.
For example, a term plan could make an apt fit for a financially well-placed individual, who has no insurance cover and doesn't expect the insurance policy to generate returns.
Simply put, a term plan is a pure risk cover plan without any maturity benefit. The next step would be to scan through the various term plan offerings and to select a term plan that best matches the insurance seeker's needs.
Another element which could put a spanner in the works is the insurance advisor. For instance in the case above, the insurance advisor is unlikely to recommend a term plan, since he generally makes the least earnings on it as compared to unit linked insurance plans and endowment plans.
As a result, most advisors prefer to 'peddle' the latter, which are big commission earners, irrespective of the client's needs or risk profile. Hence it is imperative to be associated with the right insurance advisor i.e. one who accords greater importance to the insurance seeker's needs over his own.
Buying insurance should never be a rushed affair either. In such a scenario, prospective insurance buyers often end up playing into the hands of their insurance advisor. The outcome - they land up with policies, which are more beneficial (read big commission earners) to the insurance advisor. Hence it would pay to commence the insurance exercise, well before the tax-planning season kicks in.
In this article, we discuss the various options from the insurance segment that are available to insurance seekers and identify the key factors to be considered.
Term plans
Term plans offer pure risk cover and merit inclusion in most portfolios. In fact, a term plan should be the first insurance product that insurance seekers should opt for. Term plans represent the most economical form of insurance i.e. they offer a high insurance cover at a relatively lower cost.
This is because only mortality charges and administration expenses are covered in the premium amount; there is no savings element. Hence, if the insured were to survive the policy term, there will be no maturity benefits i.e. the policy holder will not receive any returns when the policy matures.
Unit linked insurance plans (ULIPs)
ULIPs merge market-linked investments and insurance into a single product. In line with their mandates, ULIPs invest in equity and/or debt instruments in varying proportions. With equity markets on a surge over the last few years, ULIPs have been sold rather aggressively. It should also be mentioned here that perhaps the most instances of mis-selling have also been reported in this segment.
The expense structure of ULIPs tends to be quite unconventional; a large portion of the premium (as high as 40 per cent) during the first couple of years is deducted towards expenses and the balance invested in line with the stated mandate.
However, the expenses do even out over longer time frames. Studies conducted by Personalfn reveal that ULIPs work out to be more economical vis-a-vis comparable mutual funds over longer time horizons (like more than 15 years). Hence it is imperative that policyholders continue with policy for the entire tenure.
Another advantage ULIPs offer is the flexibility they afford to the policyholder. The policyholder can "manage" his corpus by maneuvering it across different plans. For example, when equity markets are on the rise, he can shift a part of his corpus to a debt-oriented portfolio. Hence it would help to be associated with an expert and qualified insurance advisor who can help select the right ULIP and manage it as well.
Endowment plans
Traditionally, endowment plans ranked as the most popular option from the insurance segment. Endowment plans typically invest a major portion of their assets in government securities and corporate bonds; a smaller portion can also be held in equities.
Endowment plans are geared to offer returns to policyholders on maturity. By virtue of the same, they are often perceived as investment avenues. Child plans and money back plans are variants of endowment plans.
Although they might be structured uniquely (for example, they offer returns in installments during the policy's tenure), in essence, they are endowment plans.
Pension plans
For far too long, Rs 10,000 was a defining amount for pension plans. The reason being, that was the maximum contribution (premium paid) to a pension plan, eligible for deduction under Section 80CCC of the Income Tax Act. Yet again, a case of tax-planning scoring over insurance needs.
Union Budget 2006-07 corrected this anomaly. The Rs 10,000 limit on contributions to pension plans was removed i.e. contributions upto Rs 100,000 towards premiums paid for pension plans are now eligible for a deduction. This should encourage individuals to conduct their retirement planning with the right perspective.
In conclusion, we reiterate our view that individuals must let their needs determine the insurance products in their portfolio. Each product has its unique set of characteristics and should find a place in the portfolio based solely on the same. Notwithstanding the importance of tax-planning, the same should be treated as secondary, where insurance is concerned.
Buy Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue - How ULIPs fit in - please click here.
