Owing to last year's volatility in the stock markets, insurers have once again turned their focus on traditional plans. Unlike a Ulip where investments are market-linked and costs are transparent, traditional plans work on the principle of give and get - you pay x every year and you will get 15x+y in 15 years is how most traditional plans are structured. But over a period of 15 years, this 15x+y usually translates into a paltry return. Even the bonuses that most traditional plans offer are seldom able to improve the returns. So before you succumb to a traditional plan, here are four key questions you need to ask.
What you give and get?
This is an important parametre.
Comparison: "The way to compare traditional plans is to look at the guaranteed sum which is typically the sum assured," said Rituraj Bhattacharya, head, market management, Bajaj Allianz Life Insurance. "For this sum how much premium do you have to pay over a given term is how one can compare products."
Costs: Take a traditional endowment plan for a 30-year-old for a term of 20 years with a sum assured of Rs 10 lakh on an annual premium of Rs 46,931. The guaranteed payout under this plan is the sum assured and the non-guaranteed component is the bonuses that are at the discretion of the company. Compare this with a term plan that will charge an annual premium of around Rs 2,000 for the sum assured mentioned above over the same term. In other words, you pay Rs 44,931 extra to guarantee that sum assured on maturity.
Rate of return: Use a financial calculator that gives you the internal rate of return from the net or swing the numbers past your financial planner and you will understand the delusion guaranteed return is. In the above example, the return on your investment is just 0.66%.
What are the additional benefits?
Typically, in a traditional insurance plan there are three kinds of bonuses: cash, reversionary and terminal. The premiums that you pay get invested in a life fund, which is kind of a perpetual fund that an insurance company has. "The insurer meets all his liabilities of paying claims or maturity through this fund," said Bhattacharya. "So depending upon the interest rate scenario and surpluses that this life fund has, a company may declare a bonus."
Cash bonus: Once the firm declares a bonus it becomes guaranteed. If it comes as cash, it is called cash bonus.
Reversionary bonus: The guaranteed bonus can also get added to your sum assured. This is called the reversionary bonus.
Terminal bonus: This is again totally at the discretion of the company and is paid at the end. Most companies will have some historical data of their bonus rates, which can be accessed through the insurer's website or the agent.
What happens if you surrender policy?
Typically, traditional plans are front-loaded-a large chunk of the costs are deducted in the initial years-and so in the first three years, most traditional policies don't have a surrender value. If you choose to surrender your policy within this period, you get nothing back. After three years, the policy usually assumes a surrender value.