All-round Benefits of Life Insurance: Protection, Saving & Bonus
Written on Friday, July 8, 2016
By Mr. Vishwajeet Parashar
The primary purpose of life insurance is to provide protection for the financial dependents. There are, however, savings-oriented life insurance plans which in addition to providing protection, help one to save for long-term goals. Such plans could be participatory (with-bonus) or non-participatory (without-bonus) in nature. The non-participatory plans, instead of declaring bonus which can vary depending on the profits that insurer make, may carry a guaranteed return in lieu of bonus. The element of guaranteed return in the form of guaranteed additions (GA) in life insurance plans makes them attractive to those who want fixed and assured return on their savings.
A typical guarantee plan comes with such offers - “Guaranteed addition of 7-9 percent of premium per annum” or this - “Guaranteed payouts of 126 - 138 percent of annual premium each year”. The buyer has to first understand that guaranteed addition is not equivalent to return. These guaranteed benefits accrue only on maturity. Although, actual returns would depend on one’s age, term and premium amount, the average IRR (internal rate of return) in most traditional plans, including money-back, endowments lies around 6 percent per annum. The plans ones with guarantees would carry even lower returns.
Varieties in guarantees
The structure of the guaranteed plans is not the same across insurers. Some may offer a guaranteed return-based on premium while others on the sum assured. The guarantee may also differ based on the term of the policy or even the premium paying term. Also, in some plans the guaranteed returns get added to the policy from the second year onwards while in some, it may start at a later date.
Choosing the right
As because the structure of payout is not same while returns are almost similar, choosing the right plan will depend primarily on the way the payouts are structured. And that would depend on how the plan is structured. Some of these plans are similar to money-back plans wherein there is a regular flow of income at regular intervals, while in some, there could be a lump sum payment on maturity. Further, in few of them, payouts happen after maturity for a certain number of years. The death benefit, however, is more or less same across all such plans and is higher of the sum assured on maturity or 11 times the premium or 105 percent of the premiums paid. Therefore, depending on the need, one needs to pick such guarantee plans if fixed and assured return is preferential over low returns. If one needs cash flows at regular interval in future, the payout structures of a money-back guarantee plan can come handy.
An example- Let’s see how a typical GA plan works. Assuming, there’s a guaranteed plan for a term of 10 years, but with a premium paying term of 8 years. The plan offers guaranteed payout of 150 percent of premium every year after maturity for 8 years. It means, premium is to be paid for 8 years, but life cover will run for 10 years. After maturity, payouts will happen for next 8 years. Illustratively, if premium is Rs 20,000 it has to be paid for initial 8 years. Thereafter from 10th till 17th year, there will be an annual payout of Rs 30,000. Therefore, such a plan could suit someone looking for regular income after 10 years. Similarly, there could be a guaranteed plan in which every 5th year, 125 percent of premium is paid-out while the GA is added to policy each year, to be had on maturity along with SA (less amount paid every fifth year). In few other guarantee plans, the payout could be entirely on maturity including GA and sum assured.
Being traditional plans, these are inflexible in nature. The term once chosen can’t be changed. For someone who has started saving for say 20 years might need to access one’s savings in the 16th or 19th year. Surrendering then would be costly. Most such plans also do not allow partial withdrawals. Even sum assured cannot be changed.
Bonus Based Life Insurance Plans
Bonus, in the common parlance, refers to an extra payment received over and above the assured expected income. In life insurance, the concept of bonus is somewhat similar. One is entitled to the amount of sum assured (expected income) and over and above that there may be bonus payments too.
When a life insurance company makes a profit (surplus), it is supposed to distribute a part of that profit to its policyholders, in the form of bonus payments. Equate this with companies declaring dividends on making profits in case of equity shares. The surplus in a life insurance company may arise after valuation of the insurer’s assets and liabilities and so any excess of assets over liabilities is the surplus amount. This surplus gets distributed to the policyholders at the end of each financial year in the form of bonus.
The bonus is not payable to every policyholder, but depends on the kind of policy one holds. The traditional insurance plan, such as an endowment or money-back plan can either be a ‘participatory’ (or ‘with-profit’) plan, thereby, qualifying for a bonus or a ‘non-participatory’(or ‘without-profit’) plan that does not qualify for bonuses. Understandably, ‘non-participatory’ policies come at a lower premium compared to ‘participatory’ ones.
The returns in some ‘with-profit’ policies may not depend on bonuses. Instead, in such policies, there is a ‘guaranteed addition’ (GA) to the policy. The bonus is unknown and depends on insurer’s profit while GA is an assured addition to the policy. It is disclosed to the policyholder upfront while buying the policy.
Based on the actual experience of the ‘with-profit’ fund, the insurer declares the rates of bonus for the previous financial year i.e. in arrears. The quantum of surplus and bonus mainly depend on the amount of investment income earned while other factors such as mortality, expenses also play a part. Expectation of interest rates in the future will also plays an important role while declaring the bonus amount.
The bonus is declared either as a certain amount per Rs 1,000 sum assured or as a percentage of the sum assured. For example, a bonus may be Rs 40 for every Rs 1,000 of sum assured. So, for a policy with a sum assured of Rs 1 lakh, the bonus amount will come to Rs 4,000. So, in the above example, if the term of the policy is ten years, the total bonus accumulated on maturity will be Rs 40,000. Some insurers also allow policyholders to en cash them during the term of the policy too. If the policyholder dies during the term, the nominee gets the sum assured and the bonuses accumulated till the year of death
Types of bonuses
Simple Reversionary Bonus: In most traditional life insurance policies, the bonus amount keeps getting added (accrued) to the policy and it keeps accumulating to be had on maturity. This is the case of a simple reversionary bonus. In the example above, Rs 40,000 reflects the same.
Compound Reversionary Bonus: If the amount of bonus declared, from the second year onwards, is on the sum assured plus the previous year attached bonus, it is a case of the compound reversionary bonus. In both, the total bonus amount can be had only on maturity or death as they are ‘reversionary’ in nature.
Interim Bonus: Bonuses are declared at the end of the financial year. But, what if a policy matures or death occurs before the end of that period? Insurers declare interim-bonus to take care of such situations and not to put such policyholders at a disadvantage. The amount of bonus added to the policy is however on a pro-rata basis for that specific year.
Terminal Bonus: As the name suggests, terminal bonus is added only on maturity or on death. It is a one-time bonus that the insurer may declare for policyholders who have run the policy till its original term. They will therefore, not be payable on policies which have been made paid-up or surrendered.
Unique features of bonuses
In a ‘with-profit’ policy, bonus may or may not be declared by the insurer as they are dependent on a company’s (or fund’s) profitability. The quantum of bonus may therefore differ in each year depending how much profit are generated by insurer. The bonuses are declared on annual basis for each policy year during the term of the policy, provided the policy is in-force as on the date of bonus declaration (i.e. all due premiums have been paid). Once declared and allocated by the insurer, it becomes a part of the policy and is guaranteed to be paid by the insurer on maturity or at the specific time as per the policy schedule. The amount of bonus to be added to a policy will depend on the term of the policy. Typically, whole life insurance plans are entitled to higher bonus amount.
If a paid-up policy is made, then the annual bonus added to date remain credited to that policy, but the policy will receive no further bonus additions. The bonuses attached to the policy benefits cannot be en cashed without terminating your policy. Bonuses are payable only at the time of death claim, maturity claim or on surrender of the policy.
How bonus fits in your plan?
Get a fix on the term of the policy, say, you want to save for 15 or 20 years. Ask the agent to show the bonus rate declared by insurer in the previous year for the same duration. In the present day interest rate scenario, the total amount of bonuses over 20-year will just about equal the sum assured. This should give some idea to the policyholder about the maturity value (sum assured plus bonus) to be able to meet the long term goal.
The life insurance plans, with guaranteed additions, suit conservative investors who do not want any volatility in returns and want a certain fixed amount on maturity. Conservative investors, who are willing to accept little uncertainty in maturity amount, may however stick to nonguaranteed (bonus-based) traditional life insurance plans.
Disclaimer: The mention of the word ‘Guaranteed Addition’ wherever used in the story is the part of the insurance product and the obligation is with the insurance company to meet it. Guaranteed Addition is also a generic term used in insurance industry and the responsibility to meet it lies entirely with insurance companies who offer the same.