Say NO to Traditional Life Insurance Plans

Traditional life insurance plans featured image

You have been looking to buy an insurance plan. You don’t want to purchase a pure vanilla term insurance plan since you do not get anything back. You have read about so many bad things about Unit linked insurance plans (ULIPs). So, you don’t want to purchase those either. You meet an insurance company representative/agent who talks about traditional insurance plans (kind of plans LIC sold to your parents or even some of us) which offer steady and almost guaranteed returns. Some people refer to these traditional insurance plans as endowment plans. You get excited. This is what you were looking for. Steady returns and life insurance cover. You go ahead and purchase the plan.

Well, you have committed a big financial mistake. By purchasing a traditional insurance plan, you guarantee yourself steadily poor returns and grossly inadequate life insurance cover. If that was your goal, then you have done just that. Congrats!!!

Where did you go wrong? You fell for this trap of steady and guaranteed returns. Traditional insurance plans are opaque, have hidden cost structures and have historically provided poor returns. Additionally, life cover is too low. A pure term plan or even a ULIP would have been a far better choice.

Traditional life insurance plans come in two broad variants. Participating and non-participating life insurance plans. Both the types are BAD and you should never invest in any of these plans. In this post, we will show you why. We will also demonstrate how a simple combination of a pure term and public provident fund (PPF) is far better than these traditional life insurance plans.

Before we move on to different types of traditional insurance plans, let’s first discuss a few common life insurance terms.

Common Life Insurance Terms

Maturity benefit is the amount that the insurance company pays you if you survive the policy term. Death benefit is paid to the nominee if the policy holder dies during the policy term. Sum Assured is the minimum death benefit.

Policy payment term is the number of years you pay the premium. Policy term is the number of years you are covered under the insurance plan. You get the maturity benefits after expiry of policy term. Policy term and premium payment term can be different.

Non-participating Insurance plans

Under such plans, you are aware of the death and maturity benefits upfront i.e. maturity amount is guaranteed upfront. So, you know upfront how much you are going to pay (in premium) and what you are going to get at maturity/death.

We have picked up a non-participating insurance plan ICICI Pru Assured Savings Insurance Plan to explain you the product features.

Maturity benefit = Accrued Guaranteed Additions (GA) + Guarantee Maturity Benefit (GMB).

Death benefit = Highest of (Sum Assured + GA, GMB+GA, 105% of sum of premium paid till date)

Sum Assured = 10 times the annual premium

Accrued Guaranteed Addition (GA): It is 9% for 10 year policy term and 10% for 12 year policy term. GAs will be added to the policy at the end of every year. Annual Guaranteed addition = GA rate* sum of all premiums paid till date.

Guaranteed Maturity benefit (GMB) is set at policy inception and depends on policy term, premium payment term, premium, age and gender. GMB will be known to you upfront. The details about GMB calculation are provided in the policy brochure.

Let’s consider the following example. A 30 year old male chooses a premium of Rs 50,000 per annum for a policy payment term of 10 years and policy term of 12 years. This means the policy holder will pay Rs 50,000 per annum for 10 years and will get the coverage for 12 years. Sum assured will be Rs 5 lacs. GMB will be Rs 3.18 lacs.

If the policy holder survives the policy term, he/she will get the maturity benefits. The maturity benefit will be Rs 693,269. This is composed of GA (Rs 375,000) and GMB (Rs 318,269). The net return is 4.35% p.a.

If the policy holder dies after 5 years, his/her nominee will get Rs 5.75 lacs.

You can clearly see that the returns are poor. In an insurance product, we can live with poor returns. Term plans provide zero returns. The bigger problem is the amount of life cover. For someone who can spare Rs 50,000 per year towards life insurance premium, he/she would want a better life style for his/her family than Rs 5.75 lacs can buy. So, with such products, you get guaranteed poor returns and low life cover.

Comparison with PPF and Term plan

Let’s try to build a product that provides similar risk and tax benefits as a non-participating plan does. Non-participating plans provide both insurance and investment benefits. We will pick up a pure insurance product and a pure investment product.

A term plan provides a pure life cover. There is no element of investment in a term plan. If the policy holder survives the policy term, nothing is paid to the policy holder. If the policy holder dies during the policy term, the nominee of the policy holder gets Sum Assured. We pick up a term insurance plan from ICICI Prudential (ICICI Pru iProtect Term Insurance Plan).

To take care of the investment part, we pick Public Provident Fund (PPF). PPF provides guaranteed returns (although Government announces the return every year). Hence, there is little volatility from PPF investments.

A combination of term plan and PPF will provide the same tax benefits as the non-participating plan. Insurance premium for non-participating plan qualifies for deduction under Section 80C. The maturity and death proceeds are exempt from income tax. Both term insurance premium and PPF investment can be claimed for deduction under Section 80C. Interest from PPF is not taxable and proceeds from PPF are tax-free. Hence, a non-participating plan and our combination of PPF and term provide exactly the same tax benefits.

We could have picked up mutual funds (instead of PPF) as mutual funds are better suited for long term investments. However, the risk characteristics of mutual funds and a non-participating plan would have been different. MFs carry far greater risk.

For the same 30 year old male, we take a life cover of Rs 50 lacs (greater than Rs 5 lacs in the non-participating plan). The premium for a term of 15 years will cost Rs 5,985 (inclusive of service tax). We invest the remaining amount in PPF (Rs 44,015) every year. Let’s compare the returns.

Traditional life insurance plan participating comparison

You can see simple combination of term plan and PPF beats the non-participating plan in each and every scenario. You would have got better returns if you had purchased a term insurance and invested the remaining amount in PPF (Public Provident Fund) account. Not only that, your life cover is much higher under a term plan.

We have always recommended keeping your investment and insurance needs separate. This above table just shows why. With the non-participating plans, you guarantee yourself poor returns and a low life cover. Why would you want to purchase such a product?

Participating Life Insurance Plans

Under participating insurance plan, only a minimum amount is guaranteed (upfront) at maturity and the rest depends on the quantum of bonuses announced over the policy term by the insurance company. The level of bonus depends on the performance of the participating/life fund.

What is a Participating/Life fund?

Let’s see how it works. Premium amount from the participating plans is pooled into a fund (participating fund). Every year, based on the investment performance of the fund, insurance company generates surplus returns. The surplus, if any, also depends on insurance claims of the participating plans, existing contractual obligations, future bonuses and actuarial assessment of the surplus. IRDA has mandated a minimum 90% of the surplus to be distributed among the policy holders as bonuses. Since the assessment of surplus is so subjective, performance of a participating plan is difficult to predict.

To confuse you further, there are many kinds of bonuses. There is simple reversionary bonus, compounded reversionary bonus, special reversionary, terminal bonus, interim bonus, loyalty addition and a few more. Enough to keep you confused and unduly excited.

Once declared, these bonuses are guaranteed and paid to the policy holder/nominee at maturity/death. These bonuses are not really hefty. You will get 2.5% to 3.5% of the Sum Assured per year. An insurance company may or may not declare bonus every year. Hence, there is no guarantee of bonus every year.

Problems with Participating plans

Hidden cost structure

There is no mention about the cost structure in policy brochures of traditional participating plans. There is no mentioned about agent commissions, fund management fees, policy administration charges etc. In absence of such information, it is difficult to do return analysis, even if you make assumptions about the performance of the participating fund.

Lack of transparency

It is not exactly clear how the performance of a participating fund translates to bonuses for the policyholders. For customers, a participating plan is as good as a black box. Every year, a bonus amount would pop up. You wouldn’t be able to figure out how. At least, I couldn’t. Where there is lack of transparency, you can be rest assured that customer will make the least amount of money in the entire value chain (agents, insurance company and the customers).

You can look at historical bonuses for a particular plan to get an idea of returns. Such plans typically provide 3-6% p.a. compounded returns, which is quite low over the long term.

Comparison with PPF and Term plan

We pick LIC New Endowment Plan and we will compare its performance with a combination of term plan and PPF.

Under LIC New Endowment Plan,

Death/Maturity Benefit= Sum Assured + Vested Simple Reversionary Bonus + Final Additional Bonus, if any

Simple reversionary bonus (declared annually) and Final Additional Bonus (one-time) are not guaranteed.

For the last two years, LIC has paid simple reversionary bonus of Rs 38/per Rs thousand of Sum Assured. At this rate, on a sum assured of Rs 10 lacs, you would Rs 38,000 as bonus every year. Please note that this will be paid to you only at maturity. And there is no element of compounding. So, at this rate, your total bonus at maturity will be Rs 5.7 lacs (Rs 38,000 X 15 years). This bonus can be greater or lesser than Rs 38 (per Rs 1000 of sum assured) and may even vary across years.

Final Additional Bonus (FAB), if any, is a one-time bonus and is paid in the year of claim or at maturity. This bonus is not guaranteed and you may or may not get this bonus. The FAB is paid at maturity only when the policy is in force for at least 15 years. We have considered the information about bonuses available on LIC website and a few other online resources available. For a policy term of 15 years and Sum Assured of Rs 10 lacs, the FAB mentioned was Rs 20 per Rs thousand of Sum Assured. It may be greater or less.

With this information in hand, let’s see how the plan performs as insurance and investment product. For a 30 year old male and Sum Assured of Rs 10 lacs for a policy term of 15 years, the annual premium is Rs 67,070 (exclusive of service tax). We will assume simple reversionary bonus to be Rs 38 per thousand of SA and FAB to be Rs 20 per thousand of SA.

Participating plan_PPF Comparison_jpg

You can see PPF and term plan combination outperforms a participating plan in every possible scenario. So, we do not see any rationale in purchasing participating life insurance plans. The participating plans are no good either as an insurance product or as an investment product.

Traditional life insurance plans have heavy surrender penalty

A traditional plan (whether participating or non-participating) acquires surrender value after premium has been paid for three years if the premium payment term is 10 years or more. That means you get nothing back if you surrender your policy before premium instalments have been paid for three years. Even if you surrender after 3 years, you get back only a fraction of your total premium payments.  If the premium payment is less than 10 years, the plan acquires surrender value if the premium has been paid for two consecutive years. So, the penalty for surrendering/cancelling traditional plans is extremely high.

PersonalFinancePlan Take

We advise to keep your investment and insurance needs separate. By mixing these two, not only do you consign yourself to lower returns but also run the risk of remaining underinsured.

The only reasons why you can end up purchasing a traditional life insurance plan are the lack of knowledge on your part or remarkable salesmanship on part of the salesman or both. Insurance products require long term financial commitment. So, if you purchase such products, you will be reminded of your mistake every year at the time of premium payment.

Though we do not recommend unit linked insurance plans (ULIPs), you can still make a case for investment in ULIPs as the cost structure becomes quite competitive after a few years.

With traditional insurance plans, you do not have to think much. Simply say NO. There is no element of subjectivity. Such plans offer poor returns and provide low life cover. There is no reason why you should purchase a traditional insurance plan. Stay away from traditional life insurance plans. These are neither good as an insurance product, nor any better as an investment product.

What do you do if you have already purchased a traditional plan? You do not plan to continue paying the premium. However, if you surrender/cancel the plan, you face heavy surrender charges and a possibility of reversal of tax benefits availed under Section 80C. Heavy surrender charges eat away most of your premium instalments already paid. You don’t want to continue and you don’t want to cancel. What should you do? We will address this issue in one of our subsequent posts.

Please understand the problem does not lie with ICICI Prudential Life Insurance Company or LIC or HDF Standard Life. The problem lies with the product structure itself. You can pick up a traditional life insurance plan from any life insurance company. The plan will be as bad. However, the insurance companies will keep selling as long as you keep buying such plans. So, you have to learn to say NO.

Image Credit: Moolanomy, 2012. Original Image and information about usage rights can be downloaded from Flickr.com

Deepesh is a SEBI Registered Investment Adviser and Founder, PersonalFinancePlan.in

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Deepesh Raghaw

Deepesh is a SEBI Registered Investment Adviser and an alumnus of IIM Lucknow. Deepesh provides customized Financial Planning and Investment solutions to his clients. Deepesh is passionate about personal finance and contributes regularly to leading Business Newspapers. Deepesh appears regularly on personal finance shows on Business Television.

47 Responses to Say NO to Traditional Life Insurance Plans

  1. Praveen Varganti says:

    This really helped me to understand about traditional plans and their disadvantages compared to term and PPF…

  2. Sibi Balan says:

    Dear Mr. Deepesh,

    A very informative article and well written. I was in a dilemma on what kind of life insurance I should buy and your article was helpful in getting my priorities right. I am a NRI and I want a life cover (min 1 Cr.) with some riders such as waiver of premium, accidental benefits, critical illness benefits etc. and with no need for an investment option. AS I prefer to keep it separate as you said. It would be really helpful if you could suggest a suitable term plan which would cover me and my wife together.
    Best regards.
    CB

    • Deepesh Raghaw says:

      Dear Sibi,
      I think you are looking for a joint term life plan. Not all life insurers offer such plans.
      I am not a big fan of joint life plans. You can go through my post on joint life insurance plans here.
      http://www.personalfinanceplan.in/insurance/all-you-need-to-know-about-joint-life-insurance-policies/
      Suggest purchase separate covers for self and spouse.
      All the life insurance plans offer such benefits.
      Suggest do not go for waiver of premium option. Typically, life insurance plans end when the policy holder passes away. So, there is no need for waiver of premium. Some plans may waive off premium in case of terminal illness.
      There is no need for accidental death benefit because your life insurance requirement does not change depending upon the cause of demise.
      I have no preference for any company. Go with the life insurer you are comfortable with.
      Purchase separate critical illness and accident/disability covers.

  3. ABC says:

    All the arguments and logic is fine against buying Traditional policies. The BIG question for buying Term+PPF is – are you consistently putting a fixed amount of money in PPF regularly for so many years. Most of the people fail in that. SO sometimes common people feel more comfortable with Traditional policies as the agents will remind them of paying premium.

    I’m not for or against any of these arguments. But just wanted to point out the practical problem of Term+PPF option.

    • Deepesh Raghaw says:

      My argument is built on premise of investment discipline.
      From what I have seen, investors tend to maintain discipline when it comes to debt investments. It is mostly in case of equity investments that they struggle.
      You can set up auto-transfer in case of PPF too. Personally, I do not see this as much of a problem.
      But I agree you have a point. Remember Personal Finance is personal.

  4. sunilkholkumbe@gmail.com says:

    Really helpful article Deepesh !! I changed my mind of taking an endowment insurance plan & now I will go for term insurance plan + PPF option..

  5. Arul says:

    Traditional Life insurance is heldful for
    1. Those who are not eligible for TERM PLANS. Only salaried people with proper income proof and Medical also required.

    2. Tradituonal plans comes with WAIVER OF PREMIUM OPRION, which is not possible in PPF or any other investment.

    3.IRR rate is around 5.6 to. 5.8% (TATA AIA TAB )

    So, it is useful always if you choose the right plan. Non participating plans are even more beneficial as interest rates are coming down for your bank deposits RD and FFD.

    I am Life Planner in TATA AIA LIFE
    Contact me for more details my number 7708806534

  6. Sree chakradhar Rao says:

    thank you sir,

    i am already exiting customer in SBI life wealth builder(50,000/-PER ANNU/since 2yrs)AND LIC JEEVAN SARAL (24,000/-annu,since 5 yrs) and lic new bhimagold(9000/-per annu,since 10 yrs) ,now i am 45 yrs old ,is it ok… and what would be if i start PPf this age

    • Deepesh Raghaw says:

      It is difficult to comment. SBI plan looks like a ULIP. You can continue with it.
      LIC plans are quite old. It may make better sense to continue.
      You need to revisit your asset allocation. If you think you need to invest more in debt, you can consider PPF.

  7. Sairam says:

    Dear Deepesh,

    I took the New jeevan anand policy for sum assured for 15,00,000/- and yearly premium 82,000. I paid 41,000/-(half yearly mode) should i continue with it or not.After reading your post I realized that it was a bad decision.What are the other options for me to invest money like Mutual fundsPPF etc. along with insurance.

    Thanks.

  8. Suman says:

    I want only life cover online insurance no return on maturity. Then what type of online insurance I must search? Please advice me…

  9. Joe says:

    Regon term plan vs regon ULIP whats ur say ?

  10. Joe says:

    Regon term plan vs Regon ULIP wahts ur say ?

  11. Anonymous says:

    VERY INFORMATIVE AND EASY TO UNDERSATND YOUR WAY OF EXPLANATION .

  12. Lochan Bagul says:

    I have taken 2 LIC plans: Jeevan Anand and Endowment plan for 20 years. I am paying premium of total 90K per annum. Both have sum assured of 10L and 14L respectively. I am paying premium since 2012. What should I do? Will it be good choice to surrender these policies and go for term insurance and PPF.

    Please suggest.

    • Deepesh Raghaw says:

      Lochan,
      You should continue the policies.However, refrain from purchasing traditional plans in the future.

      • Anonymous says:

        HI Deepesh
        But as per your previous responses, I was thinking of make the policies paid up and go for term insurance and PPF.
        My Jeevan Anand plan is purchased in 2014 and Endowment in 2012. I was thinking to stop paying premium for endowment and continue with Jeevan Anand.

        Please suggest, I am confused.

        Regards,
        Lochan Bagul

        • Deepesh Raghaw says:

          Hi Lochan,
          I mentioned in my previous response. It is not all about mathematics.
          Btw, you didn’t mention in your earlier comment that Jeevan Anand was purchased in 2014.
          You don’t even provide the correct information.This is not the right approach to financial planning.
          It is for reasons such as these that I am asking you to continue with these plans. Atleast, you have something.
          Just that do not purchase such plans in the future.
          Btw, why do you want to stop Endowment and continue with Jeevan Anand?

          • Anonymous says:

            Hi Deepesh,
            Sorry I have not mention more details. Let me provide this to you.
            In Endowment plan: I have paid 4 installments of 44533 per year till now. I was supposed to pay my next premium this month. This plan is like I have to pay premium of 44533 per year for 21 years i.e. when I will be at 44 age. After that I will get returns every year for 20 years. i.e. at the age of 45 I will get around 1 lac which will increase every year and at the age of 66 I will get around 3.6 lac. So in total I will pay around 44533* 21 = 935193. and in return I will get around 40lac when I will be at 66 age. But problem here I am seeing is that I am not getting lump sum amount at the age of 45th year. I have to wait for 20 years after 45th age to get my money back. Life insurance cover of 136500 will remain. So, my plan was get this policy paid up. Get term insurance of 50Lac for 5500 premium and invest remaining say 45k in PPF for 15 years. So at the age of 45 years I will get lump sum amount of around 13.5 lac from PPF which I can invest as per my choice at that time.

            Regarding Jeevan Anand, I am paying around 45k per year for 20 years. At the age of 45, policies will get matured and I will get around 4-5 lac amount for 5 years i.e. from my 45th age till 50th age. So, I will supposed to get 20-25 lac at the age of 50. Next premium of this policy is in October, so I still have time to think about this policy.

            The only reason, I am seeing to continue with Jeevan Anand is lifetime cover and returns in lump sum amount in duration of 5 years compared to endowment.

            Let me know if this would be wise decision or not.

            Regards,
            Lochan Bagul

          • Deepesh Raghaw says:

            Dear Lochan,
            Suggest you work out the numbers yourself. Will be a good learning exercise for you.
            You may also seek professional assistance.
            As I have mentioned before, cost of a poor financial product is much higher than the cost of professional advice.
            How much do you invest every year (include life insurance premiums except term plans)? Is the LIC policy premium a strain on your cash flows?

  13. Lochan Bagul says:

    HI Deepesh,

    I also have home loan of 15lac with monthly premium of 15k for 15 years (3 years already completed). Total I am paying 90k per annum as insurance premium including my monther’s insurance premium. So I am feeling like I am paying too much in insurance premium. I am now 29 years old, married 2 years back and have child of 10 months now. So, I am feeling like I am paying too much for my future after 20 years than my present now. Yes, I feel that LIC premium is strain on me now. Other way I am thinking like by saving insurance premium I can also prepay my home loan in 7-8 years. So, in total I am feeling my purchasing power has been reduced now as very less money remains in my account to spend.

    My only concern is, is it wise to wait for 40 years (till the age of 66) to get the money back (of course with bonus). Also like I said at the age of 66 I will get 3.6 lac, will it be sufficient considering inflation at that time. So, if I put the money in PPF for 15 years, get around 13.5 lac at the age of 45 and just keep it in FD or recurring (with 8% interest compounding) for 20 years I will get 60 -70 Lac in total at the age of 66. I hope I am considering the right calculations.

    Regards,
    Lochan Bagul

    • Deepesh Raghaw says:

      Dear Lochan,
      There are many ifs and buts. And there is no black and white answer.
      Suggest you work with a financial planner who will take you through pros and cons of various approaches and help you with the numbers.
      After paying annual premium of Rs 90K for 40 years, you will get Rs 3.6 lacs. Something does not seem right.
      If you need money after 30-35 years, there is no need to take money out from PPF (which is EEE) and put in a fixed deposit (where interest is taxable). Let it be in PPF only. Btw, I am not saying you should close you policies and invest the amount in PPF.

      • Lochan Bagul says:

        Hi Deepesh
        I think you get it wrong. In endowment policy I am getting 40 lac in installments and not lump sum. So I will get total 40 lac starting from 1 lac at 45th year, increasing every year and 3.6 lac at 66th age.So it is like pention plan.

        Lochan Bagul

        • Lochan Bagul says:

          pls reply

          • Deepesh Raghaw says:

            Dear Lochan,
            I have answered the best I can. These aspects are never as objective. And half-baked advice never works.
            Advise you to consult an investment adviser in your city. Seems you are looking for proper financial planning.
            He will explain various pros and cons of each move and you will be in a position to take an informed decision.

  14. Lochan Bagul says:

    Hi Deepesh,
    Thanks a lot for your advice. Your post is very useful. I will consult with my investment advisor and will take the decision.

    Thanks once again.

    Regards,
    Lochan Bagul

  15. Kumar Borugadda says:

    Dear Deepesh,

    I am a 37 years old man, my annual salary income is 432000/- i am looking for term plan+ppf policy. i can afford rs.50000/- premium per year. can you suggest me suitable plan for this.

    Thank you

  16. Abid Khan says:

    I have Max Life Life Gain Plus 20 Yr 6 Pay, which is the biggest mistake I have done so far. I already paid 5 premiums and only one is remaining.

    What should I do now? Should I stop or continue paying this last premium.

    • Deepesh Raghaw says:

      Dear Abid,
      I have not gone into plan details. Hence, can’t really comment.
      Since you have already paid 5 out of 6 premiums, may not be a bad idea to continue.

  17. Vikash says:

    Sir, regarding mutual fund is it OK to invest 10lakh in SBI magnum balanced fund and SBI dual advantage fund each?

    • Deepesh Raghaw says:

      Vikash,
      I don’t/can’t comment on specific funds.
      You can visit the “Our Offerings” section if you are interested in professional advice.

  18. Rahul says:

    Hi, An excellent read. Almost from a week I am searching and reading on this matter.

    I have jeevan aanand ( 2007) for 25 years/sum assured-400000/annual premium of Rs 17000

    Jeevan Mitra Triple cover (2007) for 27 years/sum assured 300000/ with annual premium of Rs. 13000

    And Jeevan Saral (2010) for 34 yrs/Sum assured 500000/ with annual premium of 24020

    I am thinking of doing paid up or surrender. Is it advisable at this stage. Please guide. I am 36 years of age.

    • Deepesh Raghaw says:

      Dear Rahul,
      Can you please share any analysis that you have done on your own?

      • Rahul says:

        Hi,

        Sorry couldn’t reply. Will share the details, have asked for the surrender value and paidup benefit to LIC.

        Actually, for me this work is of getting my act together. I am trying to figure what sum should I put in Life(term &OR traditional) and health insurance.

        At this age all I have got Is a small 1bhk in Mumbai. Rest totally mismanaged.

        So seeking help to start.

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