You are regularly pitched for an insurance product by your account manager or a sales agent.
And nothing confuses you anymore. You don’t know how to rate the product.
There are unusual tables and illustrations. There are emotional “what-ifs”. Buzzwords like “bonuses” and “loyalty surcharges” create the impression that the insurance company is doing you a favor. There is no need to say NO.
By the way, you don’t have to say NO.
At the same time, you don’t have to say YES until you understand what you are buying.
And that’s the topic I’m going to try in this post.
Two types of investment-cum-insurance plans
Traditional plans and unit-linked insurance plans (ULIPs).
Traditional plans have two flavors: Participating and Non-Participating.
Before we go any further, let’s take a look at a few terms.
Linked / unlinked products
Your money is invested in the capital markets and your returns are linked to the performance of these investments. Just like mutual funds. ULIPs are linked products.
Not linked means that your returns are not linked to market performance. Traditional plans (both participating and non-participating) are not linked.
Participating and non-participating plans
Participating plans share in the company’s profits. As the name suggests, the participating plans fall into this category.
Non-participating traditional plans and ULIPs are inherently non-participating.
How do you find out what type of plan is being sold?
Focus on these keywords.
- Non-Participating (Traditional) Plans: Not affiliated, not participating non
- Participating (traditional) plans: Unlinked, Participating
- Unit-Linked Insurance Plans: Linked, Not Participating
Searching for these terms in the brochure can help you find out what type of plan is being sold to you. You can find these conditions on the first or second page of the product brochure.
Non-participating plans offer guaranteed returns
Non-participating traditional plans are both non-participating and non-affiliated. Hence there is NO uncertainty about their returns. You can calculate the returns (XIRR) from the product in advance.
If the insurance survives, you will receive the promised returns.
So you know in advance what you are getting.
You just need to find out if the return is high enough for a long-term investment. To do this, you can use the IRR or XIRR function in Microsoft Excel
However, there is only one aspect to look out for.
For combined investment and insurance products (traditional plans and ULIPs), the returns depend on your age (everything else is constant).
All other things being equal (policy, annual premium, sum insured, term, premium payment period, variant), a younger person (at the time of entry) will achieve higher returns than an older investor. Because of this, legacy investors need to avoid ULIPs and traditional plans.
So a 35 year old investor will get better returns than a 55 year old investor. Both are entry ages.
If you are 55 years old and shown the illustration for a 35 year old you will be misled.
Sometimes the brochures show the illustration for a specific age (e.g. a 30 year old). There is nothing wrong with that. A brochure cannot possibly show you the cash flows for all entry ages. Keep that in mind. You can generate a figure for your age (on the insurer’s website).
Participating plans and ULIPs cannot guarantee a return
Hence, it is misleading to give the impression of a guaranteed return on ULIPs and participating plans.
In participating plans, Your final return will depend on different types of bonuses (simple relapse bonus, final added bonus, loyalty bonuses, end bonuses, etc.). Note that the nomenclature may vary across multiple plans. Well these bonuses are NOT guaranteed. Your bonuses are based on the company’s performance as you participate in the company’s profits. And a company’s performance is not guaranteed.
In ULIPs, Your money is invested in the capital markets (just like with mutual funds) and your returns depend on the performance of these investments. The performance of the investments is not guaranteed
Therefore, no one can guarantee you a return on participating plans and ULIPs.
Because ULIPs are related products, the returns on ULIPs can be very volatile.
ULIPs can be Type I or Type II
The difference is in the death benefit.
Under Type I ULIP, the candidate gets Higher from (insured sum, fund value) in the event of the policyholder’s death.
Under Type 2 ULIP, the candidate gets Sum insured + fund value upon the death of the policyholder.
All you have to do is look at the death benefit in the policy. You know whether you are buying a Type I or Type II ULIP.
Since the death benefit is higher with Type 2 ULIP, the insurance costs are higher, which affects the return.
So when you buy a ULIP as an investment, go for Type-1 ULIP.
If you’re buying to fill a serious investment gap, a Type 2 ULIP is a better choice.
Read: How Do You Choose The Best ULIP For Your Portfolio?
What do I think?
If you’re a regular reader, you already know that I don’t like mixing investments and insurance. So I advise investors to stay away from traditional plans and ULIPS. I stick to my advice. And there are reasons for such advice.
- High costs (especially if you buy through a middleman)
- Low returns for a long term investment (this is subjective)
- Lack of flexibility (early exits are usually expensive)
Then why do investors buy such products?
Again many reasons. Lack of financial knowledge. Inability to calculate the true returns on the product. Good selling point.
Still, I don’t think that explains the popularity of such products.
Most investors are looking for comfort
Consolation when I invest 2 rupees a year for the next 10 years, I get 2 rupees a year for the next 30 years. A 50-year-old invests 2 rupees per year for the next 10 years (up to the age of 60), he receives 2 rupees per year between the ages of 60 and 90.
It doesn’t bother him that the return on this 40 year investment is only 6.3% pa, or he may not even know that the product will bring in 6.3% pa
Just the convenience of a guaranteed income after retirement is sufficient. He doesn’t care about the return. He doesn’t have to chase the markets or worry about the market noise. He just has to pay the premium. Comfort.
For this peace of mind, he is ready to be satisfied with suboptimal returns. And I suppose he knows the returns (most won’t know). You will not find this information in product brochures.
In either case, low or high returns are subjective. Is 6% pa after taxes high or low for a long-term product? What is the guarantee that the investor would get better returns than this product?
Let’s consider another example.
You want to invest 1 lac per year for your 6 month old daughter. You want a product that ensures that investment continues even when you are away. Rs 1 Lac is invested for the next 18 years whether you are alive or not.
People like me will say buy yourself a schedule. If you die, the proceeds from the semester plan can be used to fund your daughter’s education. Good advice. However, this advice does not give you any consolation. You think what is the guarantee that your family will manage such life insurance revenues well? Or the proceeds will be used for your daughter’s education. Are there no products that meet such requirements?
Well, there are ULIPs and traditional life insurance plans that can give you such a product structure. Yes, these products get expensive, however How do you rate comfort and peace of mind?
Although I disagree with this “comfortable” investment approach, I know that not everyone can or will afford a competent advisor. So I have to respect the judgment of such investors. Lots of people / advisors poke fun at the financial intelligence of such investors, but I think that’s petty and unfair. You should also consider the investor perspective.
However, It is still important that you understand what you are buying.
What should i do?
Don’t mix up investment and insurance.
However, if there is a need for its convenience and safety, it is best to fully understand the product before buying it. And buy what you think you can buy.
If you are buying a participating plan (where the return is NOT guaranteed) and think you are buying a non-participating plan (where the return is guaranteed) then we have a problem. And that is the purpose of this post.
Even if both participating plans and ULIPs offer no guarantees of return, that does not mean that their risk profiles are similar. A ULIP will be much more volatile.
DO NOT buy a ULIP if you are looking for a traditional plan or vice versa
DO NOT buy a Participating Plan or ULIP if you are looking for a return guarantee. Buy a non-participating plan.
DO NOT buy a traditional plan if you have high return expectations. A ULIP is the better choice.
DO NOT buy a ULIP if you want a stable (albeit low) rate of return and a product with low volatility. A participating plan might be a better choice.
Here’s what to do when you are offered an insurance product.
- Determine the type of insurance plan (Participating, Non-Participating, Type II ULIP or Type II ULIP).
- Take the exam (Participant, Linked).
- In the case of ULIP, look at how death benefit is defined to understand whether it is a Type I or Type II ULIP. Also, in the case of ULIPs, understand the cost structure.
- For a non-participating plan, calculate the promised return.
- Try to understand the product structure. Make up your mind accordingly.
- If you are confused, it is a good idea to seek professional help. The cost of professional advice is lower than the cost of a poor financial product.