Traditional
insurance plans are sold heavily historically since LIC came into existence.
Traditional plans are a combination of insurance cover and saving element
coupled with tax benefit. Previously only LIC was pushing for these products
but now private insurance companies have also aggressively launched many
traditional plans due to ULIP products becoming difficult to sell now as the
stock prices have corrected. Birla Sun life, which is the pioneer of
unit-linked plans in India, also had to come out with traditional plans to
survive and sustain in the market. Traditional plans are very easy to sell as
they are not complex as compare to ULIPs. Endowment plans, money back plans,
whole life plans and children’s are different genre traditional plans available
in the market. Traditional insurance plans are mostly sold as tax saving
instrument therefore nobody calculates the returns while buying these products.
Traditional
plans are neither flexible nor give good return in the longer run. They offer
lower insurance cover viz a viz premium paid. Under the traditional plans you
have to pay the premiums for longer terms. Under Any default in premium
payments will lead to cessation of your risk cover. There is heavy surrender
charges associated with traditional plans if policy is terminated during the
term. Most of the people are under the impression that there are no charges in
traditional plans, but the reality far from this perception. All the charges
including insurance cost, office expenses and commission charges are built-in
in the premium. The same cannot be identified separately as they are included
in premium and are not shown separately like as in case of ULIPs. The
traditional insurance plans neither are insurance plans in proper meaning of
the term as they offer very limited sum assured nor are they investment
products, as they are unlikely to beat even the inflation.
Investment
decisions in respect of your money are absolutely vested with the insurance
company in all the traditional plans and the policyholder has no say in any
investment decision under these plans. The regulator has prescribed limits and
composition for investment under these plans. A minimum of 85% is required to
be invested in govt. and semi govt. securities, corporate bonds and it is the
balance 15% that is allowed to be invested in equity market. The point is
whether traditional plans are investor friendly or not or they are agent
friendly. We need to agree that insurance distribution is agents driven. In
other words insurance in India is sold and not bought. The agents sell only
those products where they will earn more commission. Agents are promoting
traditional plans heavily because traditional plans pay around 35% commission
in the 1st year and 5% renewal commission thereafter till the
premiums are paid. Traditional plans are easier to sell as compared to ULIP, as
sum assured and bonus declared are guaranteed since there is no market risk
under these plans.
Now
there is another bad news in the budget presented last week. It has proposed to
increase service tax on traditional plans of life insurance plans from 1.55% to
2.06%. This proposal will very badly hit the traditional plans as the overall
returns will come down. Just 3 years back service tax on traditional plans was
1.03%, last year it was increased to 1.55% and is doubled to 2.06% in this
budget. Traditional plans are debt oriented plans as substantial investment is
done in government and corporate bonds and only 15% is invested in equity. If
one has to compare the returns of this combination of heavy debt and defensive
equity than mutual fund’s Monthly Income Plans (MIP) score better. One can
expect around 10% average return from this product of mutual funds. IRDA has
put a cap on maximum expenses in ULIP plans at 3% and as traditional plans have
more charges inbuilt and are around 5%. If you earn 10% return on investment
corpus under traditional plans and 5% is paid towards commission and other
administrative expenses than you will be left with 5% return only. Now suppose
you have to pay more premium because of the hike in service tax than your
return will come down further by 50 bps. I feel that the average annual returns
on the traditional plans will come down to below 5% in coming days. It is much
better to take a term plan and invest balance in PPF as PPF also gives tax
benefit and maturity is tax free. This combination of term and PPF will give at
least 1.5% to 2% more return compare to traditional plans.
LIC
presently does not charge service tax to its policy holders but is absorbing it
at its own. But one has to see how long LIC can do this. Even If it continues
with the same strategy than bonus rate will come down or at the end loyalty
bonus will not be paid. All private
players are already levying service tax on its policy. IRDA is silent and not
taking any steps to reduce charges in traditional plans. One should also note
that DTC proposes to reduce the life insurance premium exemption limit from
present Rs. 1 lakh to 50,000 and is also clubbed with health insurance and tuition
fees paid for two children’s. Investors have to be cautious while buying
expensive traditional plans. We strongly advise our clients not to mix
insurance requirement with investment and always follow need based theory while
calculating life insurance need.
This article first appeared at moneycontrol.com on 24th March'2012
