Types of Life Insurance Policies
September 12 , 2012

Life insurance policy is a value contract that pays a sum of money to the insured or his/her beneficiaries in the event of death. In return of the guaranteed sum, known as sum assured in insurance parlance, the insured pays premiums to the insurer. Life insurance covers risks an individual faces to his/her life. Some risks we face are untimely death, illness and accidents. Life insurance mainly covers the risk of untimely death. Some life insurance companies offer additional benefits called riders to cover risk of illness and accident. Some also offer annuity products to cover the peril of lack of income due to prolonged life after retirement. Yes, living too long is considered a risk these days!

We classify life insurance policies into four types:

1. Term policies

Term policies, which are true-breed insurance policies, don't pay back anything if the insured person survives the term of policy. They ought to be viewed as expenses made towards precaution against loss of potential income. Every life insurance company has at least one term plan in their offering albeit it may be the least promoted. Term policies are the cheapest insurance products since majority of the charges, such as agency costs, fund management charges are either minimal or are totally done away with. In a typical term policy, the sum assured is 500 times the annual premium and is still higher - up to 1000 times in an online policy.

The other breeds are those that mix insurance with investment. Those policies whose investment component is linked to securities markets are popularly known as ulips. Those policies that invest in safer debt securities and thus are able to 'guarantee' return of a certain percentage of sum assured are known as traditional policies. There are pension plans created to cater to the need of retirement income.

2. Ulips

Unit linked insurance plans (ulips) offer negligible life insurance. They attempt to generate returns for the policy holder by investing in funds designed to cater to risk appetite. Policy holders can choose the type of fund they want their 'investment' to go into, from among 5-6 types differing in asset allocation. The fund for highest risk takers would invest in mid-cap stocks, for lesser risk takers the money goes to blue chip stocks and going down the ladder you can choose to stick to funds that invest in short term securities.

The returns of ulips are linked to net asset value (nav) of the fund. Ulips work similar to mutual funds with the only exception of returns lagging far behind mutual funds having similar portfolio. Ulips are unable to give returns matching that of other funds due to high charges associated with them. Charges by the names of premium allocation charge, fund management charge, policy administration charge and mortality charge eat up a big portion of premiums, especially in the initial years. Only what is remaining can go for investment. Unfortunately, unlike the scenario in mutual funds, the regulator has not capped charges on ulips so whatever the insurer decides is the charge. In short ulips are a poor choice, both to provide insurance and return on investment. Yet you're better off with a ulip than with a traditional policy.

3. Traditional policies

Traditional policies combine insurance with savings. They invest in conservative debt products to generate returns that do not even match that of a plain vanilla fixed deposit. They come in three flavors- money back, endowment and whole life. They differ in terms of when or how often benefits are paid out.

1. Money back policies

Money back policies make payment at regular intervals throughout the term of the policy. A definite percentage of sum assured is paid out periodically and the remainder is paid at maturity. In case of death before end of term, the entire sum assured is paid. Bonuses earned during the term are compounded each year and are added to the account. Life insurance component in these plans is too small.

2. Endowment policies

Endowment policies are the most popular of all life insurance policies in India. Premiums are to be paid for a certain term and maturity benefits are returned at the term's end. Sum assured and bonuses accumulated are paid to the beneficiary in case of demise before the term end. The sum assured is mostly just about the sum of all premiums paid.

3. Whole life policies

Whole life policies provide protection through the lifetime of the policy holder or till whatever age is specified by the insurance company. No benefits are received by the policy holder during their lifetime. This protection obviously comes at an inflated cost. Premiums are to be paid throughout the policy term. The prospect of being insured for lifetime may look attractive to some but if the purpose of insurance is remembered, that is to protect potential income streams for dependants, most will agree that insurance for the retired is a superfluous expense and is in fact a drain one's finances, given that these policies don't qualify for good investment avenues.

Of late, insurers in a bid to attract customers and boost business have come up with combinations of the different flavors. There are whole-life endowment policies which entitle the policy holder to get maturity benefits at the end of the policy term. Ulip version of money back policies are being offered by some life insurers. 'Better' ulip versions of endowment plans are also available.

4. Annuity plan

The last kind of life insurance is annuity plan or pension plan. Annuities are in fact the reverse of life insurance. The insurance company stops paying when the policy holder dies. During the vesting period the policy holder contributes premiums. At the point of vesting, which is at the end of the accumulation phase, the corpus is paid in two parts. 1/3rd of the corpus can be taken away as lump sum. Remaining 2/3rd must be used to buy an annuity from the same insurer or any other. Alternately the entire corpus can be used to buy annuity. Annuity is paid out as regular streams during policy holder's lifetime or till the end of the term, as chosen by the policy holder.

With all said and done, term policies are the only sensible insurance policies to have. All others that combine insurance with anything else will rob you of potential financial benefits.

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