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Should you choose early exit benefit in term insurance?

Should you choose early exit benefit in term insurance?

But, remember there are no free lunches, and the early exit benefit, too, comes with stringent conditions. Early exit is a benefit that is similar to the terminal illness rider, premium break, etc., available on a term insurance policy. It is different from a term plan with a return of premium (TROP), in that it allows policyholders to discontinue their term policy within a specified window and get the full premium back, net of GST, paid till that point. Currently, three insurance companies offer this benefit on their term insurance policies (see table). Different from TROP In TROP, the full premium (excluding GST) is paid as survival benefit at the end of the policy term if the policyholder lives through the entire term of the policy. If the policy is surrendered mid-term, policyholders are paid the surrender value (assigned after the first two years). TROP is an expensive feature as the premium on the former works out to almost double the premium on a regular term plan (see table). This is because the insurer guarantees a payout to the policyholder/beneficiary in TROP, unlike a pure risk term cover that only pays death benefit. Premature exit benefit, on the other hand, comes at no premium difference.   Mint View Full ImageMint  Exit benefit gives policyholders an option to terminate their term plan prematurely within a limited, predetermined window. But here is the catch: The duration within which you can discontinue the policy to get the premium back is 1-5 years and opens up when you turn 55-60 years, typically the age when you are closer to fulfilling your financial liabilities and may not need life insurance any longer. So, instead of paying the premium for a longer duration as with TROP, you can terminate the policy a little before maturity and get back the premium. Do note that the worth of the premium amount erodes each year on account of inflation. For instance, if the total pemium for a 40-year TROP of ₹1 crore paid over the policy term works out to ₹8 lakh, you will be paid back this premium in lump sum after the policy matures. However, if you were to consider inflation of 6%, the value of ₹8 lakh would be just ₹80,000 after 40 years. The same concept applies to the early withdrawal benefit too, but you would pay a much lower premium and for a shorter duration. Take note that if the policy is discontinued outside of the exit window, you will not get your premium back. Is it really zero-cost? It is not accurate to advertise this benefit as ‘zero-cost term plan’ because only the base premium amount after deducting 18% GST is paid back. The extra premium that is paid on add-on features is also deducted by some insurers.
“The big upside is that the policyholder does not have to pay an extra fee or a higher premium to avail it, unlike in the case of TROP. The additional benefit comes at zero cost,” said Sajja Praveen Chowdary, business head, term life insurance, Policybazaar.com. Devil is in the details Policyholders should take note of the stringent terms around the withdrawal window. For instance, in the case of HDFC Life’s plan, the exit window opens in the 30th year, but the benefit is not available during the last five years. So, if you were to buy the policy for 35 years, you will qualify for the benefit after 30 years but won’t be able to avail it because of this clause. However, if the policy term is 36 years, you will get a one-year window between the 30th and 31st policy year to avail the benefit. Similarly, with Bajaj Allianz Life policy, the policyholder has to fulfil two conditions to qualify for the benefit—the policy term is at least 35 years and policyholder’s age should be 68 years or more at the time of policy maturity. Should you buy it This benefit will work well for those who want to terminate their life insurance policy once they no longer need it. The exit benefit will prompt more people to buy pure risk term insurance. “India as a market is used to getting money-back from insurance. It would take a massive campaign of the size of polio eradication to change this mindset. Given this mindset, the zero cost or early exit proposition will hopefully get many sceptics who earlier shied away from buying a pure risk term insurance to sign up for one,” said Mahavir Chopra, founder, Beshak.org. Read the terms around early exit carefully before signing up. Also, since the window is a short one and will open 25-30 years later, mark it now so that you don’t forget to avail it.

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Tax benefits matter, but watch out for tricky insurance policies

Tax benefits matter, but watch out for tricky insurance policies

Debroop Roy, 26, was approached by a family friend, doubling up as an insurance agent, with a lucrative investment plan. Roy will have to invest ₹1.2 lakh every year for 12 years and from the 13th year onwards, he will get ₹1.3 lakh annually for the next 34 years. That’s not all. The ₹14.40 lakh paid in premiums over the first 12 years will be returned fully in the final year of the investment term.

“The plan caught my attention as it promises guaranteed annual income well into retirement years and also returns the total investment amount. But, I approached a financial expert before committing as I’m aware how traditional insurance policies are pushed during the tax-saving season,” said Roy.

Roy was right in doing that. The internal rate of return (IRR) on this traditional insurance policy is 6%. In an insurance policy, IRR gives you the rate at which the invested money will grow to yield the guaranteed maturity amount in relation with inflation.

Mint calculated the IRR of three different traditional life insurance plans–one endowment plan and two money back plans with and without return of premium options–and found traditional insurance plans with policy terms of 20-35 years typically yield 6% (see graph). This is less than other comparable fixed-income investment options of the Public Provident Fund (PPF) and Sukanya Samriddhi scheme, which also enjoy triple taxation benefits like life insurance products, that are currently offering 8.1% and 7.6% annual interest rates, respectively.

 

MintView Full ImageMint

“Policies bought 20-25 years back are maturing to yield 6%-7%. It is worth noting that 20-22 years back, 10-year G-sec yield was 12%, 30-year G-sec yield was around 14% and AAA bond was 16-18%. During that time if somebody invested in AAA bonds and reinvested after 5-10 years in a 10-year G-sec bond, the return on investment would have compounded a minimum 9%. If you compare this, traditional insurance plans are a strict no,” said Vijai Mantri, co-founder and chief investment strategy, JRL Money.

The idea is not just to see what you earn on your investment but also to draw attention to the acute shortfall in insurance coverage that such plans offer. “The primary call of insurance is protection and endowment plans fail to achieve that,” said Mantri.

The shortfall

As a general rule, financial planners suggest buying a life insurance cover of 10-12 times one’s annual income. This is totally affordable if you buy a pure risk term plan. For example, a 30-year-old woman has to pay around ₹11,000 in premiums annually for a ₹1 crore life cover. In a traditional plan, on the other hand, affordable premiums offer an abysmally insufficient cover.

“In an endowment plan, you can either pay an affordable premium or get sufficient coverage. If you want to buy a life cover of ₹1 crore through an endowment plan, you’ll have to shell out ₹6 lakh – ₹7 lakh annually on the premium alone,” said Prableen Bajpai, founder, FinFix Research and Analytics.

The pull factor

It’s no secret that traditional insurance plans are aggressively sold in the last quarter of every financial year when taxpayers scramble to make last-minute tax-saving investments. The appeal is not just a tax break on the premium but also tax-free maturity proceeds.

“Maturity proceeds, including bonuses, received from life insurance policies are fully tax-exempt provided the ratio of premium paid to sum assured does not exceed 10% in any year. For policies issued before 1 April 2012 and after 1 April 2003, it is 20% of the sum assured,” said Sujit Bangar, founder, Taxbuddy.com.

Kartik Sankaran, founder, Fiscal Fitness, is of the opinion that tax breaks on life insurance policies prove to be more expensive than paying the tax. “Maturity proceeds are tax-free and you get a tax break today but you live with over 20 years of poor returns. One should rather allocate the premium in a mix of term plan and equity-linked savings scheme (ELSS) fund. Even after paying long-term capital gains (LTCG) on an ELSS fund 20 years later, you will have more net earning.”

Insurance policies lack liquidity and flexibility and, hence, are not the ideal tax-saving tool under section 80C. In comparison, ELSS, PPF, and National Savings Certificate score higher on flexibility as they have shorter lock-ins of 3 years, 15 years, and 5 years, respectively. Partial withdrawal on PPF is allowed after 5 years.

The idea of protection and saving in one plan along with guaranteed returns make traditional plans still very attractive to many investors. “As long as the customer knows what he’s buying, it’s alright but the problem is that selling practices are such that these plans are sold without properly explaining the commitments of long lock-in and that the premium has to be paid for a couple of years and not just the first year,” said an industry expert who did not wish to be named.

Policyholders, said experts, should ask questions on IRR, lock-in period and payment terms before buying a policy.

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India must look at uniformity of insurance

India must look at uniformity of insurance

The regulator, probably for the first time, acknowledged the problem of choice the common man was exposed to. When customers go looking for insurance for their family, they are flooded with an endless number of products with each having its own unique features.

The motive behind the standardization of policies was simple. Let’s have insurance products with standardized wordings designed by the regulator. Customers wouldn’t get overwhelmed with fancy products and their fancier benefits and drop out. They could simply compare prices among brands and cover their basic healthcare risks.

Two years down, when our research team at Beshak went to check the success of these products, they found the adoption rate for such standardized products to be dismal. Especially long-term products like term life and health insurance, where customers commit big premiums for the long term, in most cases for their lifetime.

A quick dipstick check by Beshak on toll-free numbers of leading insurers was enough to figure that these plans are not being offered or even mentioned when one inquires about health or life insurance. Only when our team specifically demanded these policies was there a reluctant mention of these products.

The situation is even trickier when it comes to term life insurance. IRDAI has not only mandated a standardized product but also removed many key underwriting restrictions that were an integral part of the products on offer so far. So, while many insurers are displaying this product online, our research found that they are being sold at a premium that is 50% higher than that of a regular term life insurance plan.

Why did standardized products not work?

My observation from more than 15 years of experience in this space is that the distribution-driven insurance industry is simply resistant to the plain commoditization of products.

Commoditization of products would simply mean commoditization of the brand. Sales based on standard products would be primarily price-driven, which will only bring down the margin and profitability of large brands that command a premium today.

Successful standardization of products is also likely to make many distribution channels redundant. There would hardly be any “sales” involved – thus probably reducing the distribution margins too.

Insurers are, in fact, under constant pressure to benchmark their product with the latest ones in the market and stay relevant to distributors. As per our check on the IRDAI portal, there have been 19 new products and 75 product revamps filed only in retail health insurance in the last year alone.

The problem continues

The problem of complexity, the regulator originally wanted to solve, hence remains. As a research platform, we are constantly scrutinizing insurance policies. Our team finds it arduous to compare policies and their often twisted wordings.

We just can’t imagine a customer being able to find the time and inclination to compare and comprehend the differences in the various insurance policies.

For instance, comparing the reinstatement benefit in health insurance can be a frustrating experience. There are probably an equal number of variations in the restoration benefits as there are products. Every product, even two products from the same insurer, could have different restoration benefits.

Another case in point is the definition of permanent disability as a rider in different life policies.

The three top life insurance policies that we picked up had varied definitions for total permanent disability. For instance, one insurer defines disability in terms of the capacity to perform activities like mobility, bending, etc, while another insurer defined the ‌same rider in terms of disability of a certain part of the body.

On one hand, the world is moving towards simplification of products and experience, and on the other hand, the insurance industry is caught in a vicious war of features and benefits that only puts off a serious customer.

Standardization efforts need a 2.0 version!

Now that the new chairperson has joined IRDAI, we think the regulator should focus on the standardization of definitions instead of standardizing entire products. This would be a much better win-win solution on the ground for both the industry and the customers.

Standardizing all core offerings and conditions in the product across insurers can dramatically reduce the anxiety and the pain the end consumer goes through in understanding and comparing complex insurance products, thus help‌ing faster, well-informed decisions from customers, which is the ultimate goal of every stakeholder in this industry.

Mahavir Chopra is founder & CEO at Beshak.org.

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