Keep costs at bare minimum

Three types of life insurance plans are available: term,traditional,and unit-linked plans.

Term plans

A term plan offers only life cover and does not make any investment. If the policyholder dies during the tenure of the policy,the nominee gets the sum assured. But if he survives the policy term,he does not get any money on maturity. According to Surya Bhatia,a Delhi-based financial planner,While buying a term insurance plan,go for the policy that charges the lowest amount.

The premium charged for this policy takes into account mortality charge and a small percentage goes towards the commission paid to the agent. Mortality charge depends on age,health,and sex of the insured.

Traditional plans

Quite popular in the heydays of Life Insurance Corporation of India i.e.,before the life insurance sector was opened up to private players,these bundled products lack transparency. Three types of plans are available under this category: endowment,moneyback and wholelife. The life cover offered by these plans is more expensive when compared with term plans. Charges levied by insurance companies do not vary much from one traditional policy to another and include cost of cover a type of fee and mortality charge.

Unit-linked policies

Unit-linked insurance plans Ulips are more transparent compared to traditional policies,so customers can clearly see the returns their investments have earned and the charges levied. Due to their greater exposure to equities,Ulips have the potential to offer better returns. But here the investment risk is borne entirely by customers while in case of traditional products the insurance company tries to smooth out customers returns by drawing from the investment pool in bad years.

Two types of Ulips exist: type I and II. Type I Ulips give the insured the higher of the sum assured or the fund value as death benefit. Type II policies,on the other hand,pay you both the sum assured and the fund value. Next,let us turn to the charges levied by Ulips:

Premium allocation charge PAC. This is usually front-loaded and is the biggest cost component in a Ulip. It is levied as a percentage of premium and goes towards meeting the costs incurred while underwriting,initial and renewal expenses,and commission expenses. PAC ranges from 20 to 80 per cent for the first year and tapers off during the course of the policy. While some companies prefer to take a large chunk of the premium in the first year,others amortise the charges over the tenure of the policy, says GLN Sarma,chief actuary,Bharti Axa Life Insurance.

Policy administration charge. This charge accounts for expenses incurred in accounting,actuarial activity,sending periodic statements and reminders,and on maintenance. Some companies levy this charge as a percentage of premium,some as percentage of sum assured,and others as a fixed fee. It is deducted every month, says Sarma.

Mortality charge. This is levied to provide for the cost of insurance. It depends on factors such as age,amount of coverage,and state of health,among others. It is deducted every month.

Fund management charge. As Ulips offer a number of investment options to consumers,they charge a separate fee for each fund. Usually,for a secure fund that invests in government bonds and money market instruments the charge is 0.5 per cent of fund value. For equity and balanced funds it varies from 1.5 to 2.25 per cent. These charges are deducted as a percentage of fund value on a daily basis from the NAV of the fund, says Sarma.

Apart from these,other expenses clubbed under discretionary charges are also levied. These include switching charges and surrender charge. Usually,companies charge Rs 100-500 per switch if you switch more than four times .

In type I Ulips,the mortality charge is levied on the sum at risk the amount the insurer has to pay in case of death,which is the sum assured minus the fund value. In type II Ulips,it is charged on the entire sum assured. It is better to take a type II Ulip than type I.

Bottomline

Ideally you should buy a term cover to meet your insurance needs and a mutual fund for your investment needs. This has several advantages. One,for a given sum assured,you get the highest amount of life insurance with a term policy,which ensures that you are adequately insured. Two,if the mutual fund doesnt perform well,you can quit it. Most funds dont charge an exit load after one year. Exiting a Ulip can be a costly proposition in the initial years. Moreover,the charges that you pay for a term policy and a mutual fund are low. Costs could work out to be lower in case of some Ulips,but only if you stick to them for a long tenure.

If you prefer convenience to flexibility,you could opt for traditional policies or Ulips. Before buying any of these plans,compare the charges. Ulips are more transparent than traditional products. Consumers should compare different Ulips before buying, says Vishal Gupta,associate director marketing,Aviva Life Insurance.

Besides charges,compare the yield net of charges in a plan. To compare products of two companies,ask the agent for a benefit illustration for a particular sum assured,say Rs 5 lakh,and let all the other inputs tenure,premium,etc be the same. Then compare the fund value for different years and the final fund value at the end of the tenure. This will help you see which product charges less. You can also look at the performance of different funds over a period of time vis-à-vis their benchmarks before buying a

policy, says Bhatia.

To reiterate,charges and returns go hand in hand: to earn higher returns,buy instruments that charge you less. u

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