ATM :: Don’t fall for traditional plans

RAJALAKSHMI NIRMAL | January 11, 2014 | Business Line
The new regulation has not capped charges and the traditional plans continue to be costly.


While the market-linked plans of insurance companies were refurbished long ago, traditional plans, which offer assured returns, continued to have features that were loaded against the investors.

The Insurance Regulatory and Development Authority (IRDA) has tried to address this by coming up with a new set of regulations for traditional plans. The deadline for insurers to comply with these rules passed on New Year ’s Day.

Most insurers have re-launched their old products in the last two weeks based on the regulator’s mandate. But traditional insurance plans are still far from a mouth-watering proposition for investors.

Yes, you may be shelling out less to the agent and getting a higher surrender value if you hop off midway. But despite these changes, these plans remain high-cost investments.

What has changed

The new guideline has improved the surrender value under traditional insurance policies. Now on, the first year premium paid will also be counted in surrender value calculation, and, policies of term less than ten years, will acquire surrender value after the second year itself. It also limits agent commissions both on long term and short term policies.

It has been mandated that revenues from online sales and through other direct channels, will have no commissions and that the benefit here will have to be passed on to the customer. There are also stipulations on minimum sum assured under a policy, reinforcing the point that these products are essentially insurance policies.

Higher Commissions

For traditional plans such as endowment and moneyback policies, around 35 per cent of your first year premium (on policies where premium payment term is 12 years or more) will now flow to the agent. Compared to Unit-Linked Plans which pay 5-12 per cent of the premium in the first year as agent commission, the charges in traditional plans still look excessive.

Commissions need to be trimmed further to improve effective returns meaningfully. Also, there is no cap on total charges under a traditional plan unlike in ULIPs. In unit-linked plans, the investor can be sure that the insurer will not take away more than 2.25 per cent of returns, as this is maximum allowed difference between gross and net yield under the regulation.

The best of traditional products even now may give you just 5-6 per cent returns, with outer limits depending on bonus declaration.

Surrender to pinch

If an agent tells you that lock-in requirements on traditional polices have been relaxed, don’t fall for it. Surrendering a traditional plan in its initial years will still be a costly affair. Earlier, the surrender value amounted to 30 per cent of the premiums paid till date, excluding the first year premium.

Now it is 30 per cent of total premiums paid. For example, if you paid Rs 1 lakh for three years, your surrender value in the fourth year will be Rs 90,000 now against Rs 60,000 earlier.

A policy of term less than 10 years will acquire surrender value after the second year and one of policy term over 10 years, will acquire surrender value after when three year premiums have been paid.

Higher cover

IRDA has also asked insurers to ensure higher sum assured under traditional insurance plans.

For a 45-year-old person, the minimum sum assured now has to be 10 times the annual premium and for someone above this age, the minimum sum assured has to be seven times the premium. Now, though this ensures a higher risk cover, the costs attached are also high.

Poor Transparency

A traditional plan, does not disclose where it invests your premiums. Most of the money goes into debt investments with an allocation to equity, but investors would not have any disclosures about the investments until maturity. This is likely to keep investors in the dark about returns until the maturity.

Unlike unit-linked plans , traditional plans also don’t offer monthly declaration of NAV or fund value. The new regulation has not done anything to correct this lacuna in traditional plans.

All you would get is a benefits illustration assuming gross returns of 4 per cent and 8 per cent. As mentioned earlier, mixing insurance with investment is a bad idea.

The best option for investors across board is to take a term policy to cover all risks and a medical cover. Select unit linked plans can be looked at if their charges are low and if they have a good track record, with a modest risk profile. While traditional plans may have worked in an environment of low inflation, they may not make the cut in a high-inflation, high-interest rate scenario.

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