Five cons of single premium policies
Single premium policies now dominate the product portfolios of life insurers. But what seems like a quick and easy investment at first may disappoint you a few years in.
Until a few years ago, if you were buying insurance, it was understood that you’d have to pay the premium for as long as the policy was kept alive. If the tenure was 15 years, the premium payment term would be that long. This isn’t the case now at all. If you go through the policies offered by insurers – particularly newer launches – you’ll find that most of them are single premium plans. A single premium plan may seem suitable if you need a place to park surplus funds or if you don’t think you aren’t confident you’ll be able to pay premiums for 10 to 15 years, but there are some downsides to these plans that you may want to consider (what follows does not apply to single premium term plans).
You’re stuck with it: We wouldn’t recommend any insurance product other than pure term insurance. As you may have read, insurance isn’t to be confused with investment. Unfortunately, many investors realise this only a few years into their policy, at which time they may make their plans paid-up or surrender it altogether, so that at least their remaining premiums are kept from the high charges and low returns of the product. You won’t have this option with a single premium plan, as you’ll be giving the insurer a lump-sum at the start of your investment. So while you can put an end to a regular plan in order to generate returns elsewhere, you won’t have this option with a single premium plan.
Lump-sum investment: Even if you had a large sum of money lying in the bank, you probably wouldn’t make a lump-sum investment in a mutual fund. The stock market is too unpredictable for it to be wise to simply invest a lump-sum. ULIPs, as the name suggests are market-linked, so why should it be any different? In fact, even a regular term plan is a poor option (some schemes do offer a monthly payment option, which would be safer) as you’re still investing a rather large amount at one time in the year.
Higher mortality costs: Insurance companies set rates according to the risk they bear. If there is more at stake for them, they’ll make sure you pay. This is the case with mortality costs in a single premium policy. With Bajaj Allianz’s New Care II, for example, a 30-year-old could insure himself for Rs5 lakh for 25 years at a premium of Rs17,405, whereas his annual premium would be Rs1,490 (Rs37,250 in all). Firstly, don’t think that the single premium plan is cheaper, as investment isn’t an expense (see ‘More inefficient’ below). Instead, consider how the mortality cost will be higher. No matter how much you invest, the mortality charge is the same. With Bajaj Allianz, it’s Rs1.57 per Rs1,000 for a 30-year-old. The cost, which works out to Rs785, is the same for the single premium and the regular plan. As a percentage of your investment, though, the mortality charge is 4.5% in the case of the single premium plan. It’s just 2.1% in the case of the regular plan.
More inefficient: Insurance companies want you to dream about the returns rather than examine the costs. Examining overall costs of a scheme is incredibly difficult. Some are charged only in the first few years, others are one-time at the start of the policy, while the rest continue throughout. Mutual funds, on the other hand, have an annual cost known as the total expense ratio, simplifying matters. Getting to the point, single premium ULIPs are more inefficient even as compared to regular ULIPs, which we wouldn’t recommend buying either. For example, the Aviva Life Bond Advantage Plan, if purchased by a 35-year-old with insurance cover of Rs5 lakh for Rs1 lakh, would grow to just Rs1.64 lakh after 20 years. That’s a return of just 2.5%! These are the kind of dismal returns you could stare at if your ULIP performs poorly. One of the main reasons for this is that many charges – policy allocation, mortality, for example – are fixed. The insurer, therefore, compensates himself regardless of performance.
No tax benefits: Not that they should guide your investments, but most of the single premium plans on the market currently don’t qualify for full tax benefits (you only get a deduction on 10% of the premium). The Aviva plan referred to above, for example, only allows you to insure yourself for 1.25 of 5 times the premium. So if you pay a premium of Rs1 lakh, your options for insurance are Rs1.25 lakh or Rs5 lakh. To qualify for a tax deduction, the sum assured needs to be at least 10 times the premium. If insurers were to offer this, however, the returns would take a massive hit.
Money Saver India never recommends buying anything but term insurance plans (even single premium term plans are fine). To find out who is offering the cheapest term plans, go here. For more tips on buying insurance, go here, here and here.