NISM: Life Insurance: Securing Your Family's Financial Future
Life is full of uncertainties, and while we can't predict the future, we can certainly plan for it. Life insurance serves as a financial safety net, providing monetary support to your dependents in the unfortunate event of your demise. It ensures that your family's financial needs are met, debts are covered, and long-term goals are not compromised, even when you're no longer around to provide for them.
Elements of Life Insurance Products
Life insurance products can be defined by the benefits that they provide to the insured.
The insured would get the following benefits from life insurance products:
Death cover: Where the benefit is paid only on the death of the insured within a specified period. If death does not occur, then no benefit will be paid.
Survival benefit: Where the benefit is paid when the insured survives a specified period.
Term Insurance policies provide for only death benefit. Investment cum insurance policies will provide a combination of the above two features.
Understanding Different Types of Life Insurance
Choosing the right life insurance policy is crucial, as it should align with your financial goals and the needs of your dependents. Here's a brief overview of the common types of life insurance products:
Term Insurance:
Term insurance is a pure risk cover product. It pays a benefit only if the policy holder dies during the period for which one is insured. Term life insurance provides for life insurance coverage for a specified term of years for a specified premium. The premium buys protection in the event of death and nothing else.
Term insurance premiums are typically low because it only covers the risk of death and there is no investment component in it. It offers the most affordable form of life insurance and is an ideal way to cover the Life Insurance needs because the entire protection needs of the Insured can be covered as the premiums are affordable.
Whole Life Insurance:
Whole Life insurance policies are investment cum insurance policies that provide life insurance cover for the entire life of the insured person or upto an upper age limit specified by the insurer, whichever is earlier, provided the premiums are paid as contracted. Premium amount is fixed through the entire period. There are variations to the whole life policy such as shorter premium payment periods and return of premium option. For a traditional whole life policy, the entire sum assured plus any bonuses will be paid on death of the policy holder.
Whole Life Policies were originally designed primarily to pass on wealth to the next generation without payment of estate duty since life insurance payments on death were normally exempt from estate duty. With the abolition of estate duty, the whole life insurance policy is like any other investment cum insurance policy that needs to be evaluated based on adequacy of coverage and the inherent investment return.
Unit-Linked Insurance (ULIP)
In the case of both whole life and endowment policies, the insured has no say in deciding how the savings component in the policy will be managed. Unit-linked insurance policies allow the insured to decide on the kind of portfolio (mix of asset classes, such as debt and equity) that the insurer should maintain for the savings portion.
The risk-cover charges are deducted from the regular premium paid by the insured during the period of insurance. The balance is invested as per the agreed asset allocation. The value of the investment portfolio (savings portion) will keep changing in line with the market. The insurer announces a Net Asset Value on a daily basis.
In the event of death of the insured, the sum assured (or net asset value or higher of both or total of both, depending on the structure of the policy) is paid to the beneficiaries. If the insured survives the insurance period, then the net asset value is returned.
Endowment Policies
Endowment is an investment cum insurance plan with the same premium being paid every year. If the insured person survives the tenure of the plan, the insurance company returns the investment portion of the premium along with actual returns realised on them. This actual return is normally calculated and declared every year (called accrued bonus) but paid only at the end of the tenure.
After the insurance period is over, a lump sum is paid out, equal to the sum assured plus any accrued bonus as above. Accrued bonus is a figure that is not pre-defined at the commencement of the policy but is generally calculated at the end of every year. If death occurs during the term of the policy then the sum assured and any bonus accrued till death are paid out.
Conclusion
The primary job of any insurance company is to provide risk coverage and not investment products. There are other entities that specialize in providing investment products. Ideally, risk coverage (insurance) products should be bought from insurance companies and investment products from entities that specialize in investment products. Even if an insurance cum investment product is being considered, it can be evaluated as an insurance product that also has investment elements in it.
The first thing is to de-couple the insurance and investment elements of the instrument. Then the adequacy of the risk coverage needs to be examined. If the risk coverage is not adequate, then the instrument does not meet its primary goal and should be eliminated. Only after this primary requirement is met, should the investment return be considered separately to see if it is suitable for the investor and meets her requirements and is also comparable with investment products with similar profile.
Source: From NISM XB
References:
1. SEBI Circular No. SEBI/HO/IMD/DF3/CIR/P/2017/114 dated October 6, 2017, and SEBI/HO/IMD/DF3/CIR/P/2017/126 dated December 4, 2017
2. SEBI Circular dated September 11, 2020