Ignore traditional plans even after October
The IRDA has revised its guidelines for all traditional insurance schemes, including endowment plans. But the product won’t get any better, particularly if you won’t stay till the very end.
The Insurance Regulatory and Development Authority (IRDA) issued new guidelines for traditional plans early in the year. Traditional plans include endowment schemes, moneyback policies and whole life plans. The regulator gave the much derided unit-linked insurance plans (ULIPs) three years ago, slashing commissions, improving surrender values and capping most charges.
Its guidelines to the traditional plans will be effective from October 2013. Reports that the changes will significantly improve the products have surfaced. They even advise waiting until October to buy these plans. In the following points, we discuss the changes and argue that traditional plans will remain a poor option:
They will remain opaque
Traditional plans typically give low returns, of 5% to 7%, going up marginally when bonuses are declared by the end of the policy term. Where your premiums are invested is mostly under wraps. All that is known is that the investments are usually in debt schemes. The guidelines do not address this problem at all. The products will remain opaque. The bonus depends on the profitability of the insurer itself. It’s impossible to say what a company’s financial situation will be years from now.
Surrender value will still hurt
Sure, these are long-term schemes. But there’s little justification for high surrender charges. If a person’s financial situation changes or if you realize how poorly the product performs, why shouldn’t you be able to exit? Currently, the surrender charge is frightening, if you’re invested in one of these schemes. Every traditional plan offers a surrender value of 30% of all premiums paid minus the first-year premium. That’s huge. From now on, the guaranteed surrender value will be 30% of total premiums from year two (if you’re going to paying premium for less than 10 years) and from year three (if the term is over 10 years or more). This increases to 50% from the fourth until the seventh year. It’s not yet known what the value will be after the seventh year.
Commissions aren’t exactly low
Commissions eat into your investment, for sure. But lowering them doesn’t solve the problem too much. Most traditional plans are structurally flawed. Commissions just add to the problem. Until now, commissions for these plans have been as high as 40% in the first year, dropping to 5-10% in subsequent years. Little has changed for products with a term of 12 years or more. In case the policy stays in force longer than this period, the agent will still get 35-40% of the first year premium. For policies with a five-year tenure, the commissions will be lower, but not low enough. In the first year, it’s 15%, going down to 7.5% in the second and 5% from the third year.
Insurance still expensive
Much is made about the quantum of life insurance offered with these products. The revised guidelines, for example, require policies pitched to those 45 years or older to have a sum assured of seven times the annual premium. Does it matter? Of course not, if the cost of insurance within these products remains high, as it will under these schemes. What is needed is term insurance, combined with regular investment, to bring you peace of mind and grow your money.