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Life insurance primer

Life insurance primer

At MONEY TODAY, we believe that it's not enough to know how to make your money work better. While creating wealth is undoubtedly important, it's equally important to protect your wealth.

At MONEY TODAY, we believe that it's not enough to know how to make your money work better. While creating wealth is undoubtedly important, it's equally important to protect your wealth, even when you are not around. Which is why we go that extra mile to spread the message of prudent financial skills. This primer is a proof.

Almost all of you who read these 12 pages will have some form of insurance. And most would have been sold a policy that suited the agent, and not necessarily offered cover that was or is needed.

  But then, how do you know when your agent is trying to sell you a lemon? How do you decide how much insurance you need?

Or what type of policy suits you best? Is there a one-size-fits-all kind of policy? While this section does not claim to be the ultimate guide to insurance, it is the first step towards arming yourself with useful information about this product.

In the following pages, we explain what insurance is all about and the different types of policies and riders that are available. We also tell you who offers what policy.

We hope this primer will help you make an informed decision when buying life insurance.

What is insurance?

At the most basic level, insurance is simply protection against any future loss. Insurance companies or insurers enter the picture when this loss is quantifiable.

A life insurance policy is designed to pay your financial dependents a specified sum of money if you die during the term of the policy. You pay the insurers a regular sum (the premium) for a specified tenure. In case of a financial loss caused by death or disability, you or your financial dependants will be compensated.

This compensation is subject to certain conditions and depends on the type of cover you opt for, as well as the exclusions in that policy. There are four basic types of life insurance cover available, six variants of which are covered in this primer. Most products offered by insurance companies are structured around these. They apply to traditional insurance products as well as to market-linked plans.

TERM PLANS

What it is

Term insurance, or risk cover, is pure insurance. There is no element of saving or investment. This means that your dependents (or estate) will get the sum assured (the amount you are covered for) only if you die during the term of the policy. If you survive the term, you get nothing. Term insurance is the simplest form of life insurance. Once you decide on the sum assured and the term, the insurance company fixes the premium you have to pay. This form of insurance is also one of the cheapest. Just remember that if you survive the policy term, no benefits are paid.

How it works

Assume you take a term plan when you are 30 years old for a sum assured of Rs 10 lakh and a term of 10 years. Your annual premium is, say, Rs 3,000. If you die within the 10-year term, your financial dependents will receive Rs 10 lakh. If you survive the term of the policy, you get nothing at all.

ENDOWMENT PLANS

What it is

This policy combines risk cover with financial savings, and is one of the most popular life insurance products available. In this type of cover, the sum assured is paid by the insurance company even if the policyholder survives the policy term.

If he dies during the tenure of the policy, the insurance company has to pay his dependents the sum assured. The death benefit and cash value will be higher if the policy's underlying investments do well.

How it works

Assume you buy an endowment plan when you are 30. The sum assured you choose is Rs 5 lakh for a 20-year term, for which you pay an annual premium of Rs 22,000. If you die before you turn 50, your dependents get Rs 5 lakh along with any other benefits that the policy has to offer. If you survive the 20-year term, you get the sum assured, along with profits (if the policy is structured to share profits).

MONEY BACK PLANS

What it is

This kind of policy is a sub-set of the endowment plan in the way it is structured. The policyholder can withdraw stipulated sums of money over a specified period during the term of the policy without affecting the cover.

A portion of the sum assured is paid out at regular intervals.

The remainder of the sum assured is paid at the end of the policy period. In case the policyholder does not survive till the end of the term, his dependents get the full sum assured.

 An interesting, and important, feature of this type of policy is that in the event of death within the policy term, the death claim comprises the full sum assured.

What this means is that the survival benefit amounts, which may have already been paid as moneyback components, will not be deducted when the claim is settled. Similarly, the bonus is also calculated on the full sum assured.

How it works

If you buy a money-back plan for a sum assured of Rs 5 lakh when you are 30 and take it for a 20-year term, your annual premium will be around Rs 7,000.

If you die any time before you turn 50, your dependents will get Rs 5 lakh.

There's more to this policy: you get Rs 1 lakh each after the fifth, tenth and fifteenth year, assuming you survive.

At the end of the 20 years, you get the balance Rs 2 lakh and any bonus and guaranteed additions that the plan promises.

Money-back policy is more liquid and can be more easily integrated into your financial plan of your family. For instance, the year of pay backs can be planned to be the ones in which you have big lumpsum payments to make purchases or fund, say, your child's education or tuition. On an average, endowment and money-back plans are four to six times more expensive than term plans.

WHOLE LIFE PLANS

What it is

As the name suggests, a whole life policy is an insurance cover against death, irrespective of when it happens unlike other plans in which the cover is for a specified term. Under this plan, the policyholder pays premiums until his death or for a predefined period. One can also buy a single premium plan. After policyholder's death, the money goes to his dependents.

Variants of the policy let the individual dip into the cash value of the policy-withdraw some amounts of money periodically. This is an option that policyholders sometimes use as they grow older.

How it works

Assume you buy a whole life cover when you are 30 for a sum assured of Rs 10 lakh. You choose a plan where the policy matures when you turn 80, and you agree to pay an annual premium of Rs 7,000 for the next 15 years (till you are 45). In case you die any time in the next 50 years (till you turn 80), your dependents will receive Rs 10 lakh. Otherwise, you will get the maturity proceeds when you turn 80. Some insurance companies allow the plan to be extended beyond 80 years of age.

PENSION PLANS

What it is

The purpose of a pension plan is to protect against risk as well as provide money in the form of pension at regular intervals. The policy works in two ways. One, it is an accumulation tool that collects premiums and earns a return. Two, on attaining the vesting age (the year the payment is made), the accumulated fund is paid back as an annuity.

How it works

Assume you buy a pension plan with insurance when you are 30. You contribute Rs 20,000 a year for a 20-year term. If you die any time during the tenure of the policy, your financial dependents get the limited insurance cover that comes with the policy. Your better bet is to opt for a non-insurance version. Here, the money is accumulated over 20 years, during which you can decide on a vesting date when a percentage of the corpus accumulated is paid. Of the balance, you have the option to buy an immediate annuity (payout plan).

UNIT-LINKED PLANS

What it is

Unit-linked insurance plans, popularly known as Ulips, are becoming increasingly popular. That's because these plans offer life cover as well as a savings instrument. A part of the premium you pay is invested in an underlying fund, while the rest serves as your insurance premium. Ulips are offered with death benefit or with death benefit plus fund value. More important, Ulips offer investors flexibility and transparency, giving information about how the policy is working.

How it works

Assume you pay Rs 20,000 as annual premium for a Ulip. Say 20% or Rs 4,000, is deducted as various charges in the first year (this reduces over time).

If you buy this plan when you are 30 and opt for life cover of Rs 5 lakh, around Rs 750 is deducted as the insurance premium.

The investment amount left is Rs 15,250, which is invested in any of the underlying funds on offer-debt, balanced and equity or a combination of these.

RIDERS: ADD-ONS TO YOUR PLAN

Riders are additional benefits attached to the basic life insurance policy. They are generally limited in size, relative to the insurance cover bought, and may have separate terms and conditions, possibly with some exclusion clauses.

Simply put, riders allow you to enhance your insurance cover, qualitatively and quantitatively. They broadly cover three aspects-critical illness, medical expenses and disability insurance.

Different insurance companies might have different names for these riders, but the categories covered are the same. The term of the rider cannot be less than that of the main policy.

Critical illness

Added to a life insurance policy, it provides additional cover to the insured in the event of a critical illness. In most cases, the extra cover is paid upon diagnosis of the illness. Although the illnesses and premiums vary from company to company, most of them cover cancer, coronary artery bypass, heart attack, kidney failure, major organ transplant and paralytic strokes.

Medical expenses

This rider is intended to cover risk for ailments that may require medical treatment. With living expenses on medical treatments going up, riders in this category are useful, especially as we grow older.

Hospital cash benefit

This rider is intended to reduce the worry of settling hospital bills (room charges), which could otherwise add to the trauma of hospitalisation. However, these come with major exclusions, so make sure you check before you sign on. Also remember that most insurers cover hospitalisation only if the minimum stay is for 48 hours.

Major surgical assistance

This rider provides financial support in the event of medical emergencies. Specified surgical procedures are covered, with exclusions. Benefits under this rider are payable on more than one occasion, whenever the policyholder undergoes surgery. However, the total benefit payable in case of all the procedures is restricted to a maximum of 50% of the sum assured.

Disability benefit

This rider provides for an additional cover equal to, or less than, the sum assured on the base policy, in the event of disability as a result of an accident.

If the accident results in total and permanent disability, the rider provides for other benefits: a proportion of the benefits will be paid to the insured person every year until he recovers. Some insurers provide the "waiver of premium" benefit as well, in the event of disability.

Waiver of premium

This rider gets activated in the event of complete disability (or if the policyholder loses his ability to earn-unemployment is also taken care of at times-owing to injury or illness).

The premiums due on the base policy are waived till the person is fit again. Even though the premium is not paid during this period, the policy cover is not terminated; it continues as if the premiums were being paid. In other words, this rider acts as a "disability insurance" against your life insurance policy.

Accident death benefit

This rider comes into effect in case of death due to accident during the term of the policy. This adds to the sum assured in the life policy but excludes normal causes of death. It comes into effect only in case of death of the insured person due to an accident.

Level term cover

This rider gives you the option to increase your risk cover for a limited period and by an additional amount up to a maximum of the sum assured on your base policy. It offers death benefit alone, and addresses the need for extra protection for a specified and limited time period. This could be a period when you have taken on large debts and want to insulate your dependents from any financial liability in the event of your death during that period.

Guaranteed insurability option

In effect, this rider "insures your insurability" in the future. It gives you the right to buy additional insurance (of the nature of your base policy) at different stages in your life, without having to undergo any further medical examination.

GLOSSARY

Accident benefit: An extra feature that compensates the policyhold -er if he meets with an accident. It is available with all policies by paying approximately Re 1 per Rs 1,000 sum assured.

Annuity: A policy under which an insurance company promises to make a series of periodic payments to a named individual in exchange for a premium or a series of premiums called the purchase price.

Assignee: Assignee is the person to whom the benefits under a life policy are assigned.

Beneficiary: An individual designated in a will to receive an inheritance, or the individual designated to receive the proceeds of an insurance policy, retirement account, trust, or other asset. In an insur -ance policy, the person who is nominated is generally accepted as the beneficiary.

Bonus:  Bonus is the amount added to the basic sum assured under a with-profit life insurance policy.

Claim Amount: It is the amount payable on maturity of a policy or when a claim is raised.

Claim: Written request by an insured for the insurance company to cover an incurred loss, usually submitted on the company's standard form.

Date of commencement: The date on which cover begins, following acceptance of the risk by the insurer.

Death benefit: The amount payable, as stated in a life insurance pol -icy, to the designated beneficiary(ies) upon the death of the insured. The amount paid is the face value, plus any riders that are applicable, less any outstanding loans.

Evidence of insurability: Any statement or proof of a person's physical condition, occupation, etc affecting acceptance of the applicant for insurance.

Exclusion:  Specific hazards listed in a policy for which benefits will not be paid.

Expiry: The termination of a term life insurance policy at the end of its period of coverage.

Grace period: This provision offers the policy holder additional period of time after the due date, during which the premium can be paid. The policy continues to remain in force during this grace period and the premium continues to be payable. Same as "Days of grace".

In force: Insurance on which the premiums are being paid or have been fully paid.

Insurability: Insurability refers to all conditions pertaining to individ -uals that affect their health, susceptibility to injury and life expectan -cy; an individual's risk profile.

Insurable interest: A condition in which the person applying for insurance and the person who is to receive the policy benefit will suffer an emotional or financial loss, if any event that the policy covers occurs. Without insurable interest, an insurance contract is invalid.

Insurance proceeds: The lump sum that a policyholder or the beneficiary designated by him will receive in the event of his death within the term of the plan or when the plan matures.

Insurance: Insurance is a policy a person buys and upon that person's death, the family will be able to get a certain sum of money.

Insured: The person whose life is covered by a policy of insurance.

Insurer: Party (company) that provides insurance coverage, typically through a contract of insurance.

Lapse: Termination of a policy upon the policy owner's failure to pay the premium within the grace period.

Lapsed policy: A policy which has terminated and is no longer in force due to non-payment of the premium due.

Life assured: Life assured refers to the person whose life is being insured.

Life expectancy: The average number of years remaining for a per -son of a given age to live as shown on the mortality or annuity table used as a reference.

Life insurance:  An agreement that guarantees the payment of a stated monetary benefit upon the death of the insured.

Loyalty additions: Additional benefits available to policyholders on certain policies. These are payable only on policies that are in force. Insurers determine rates on the basis of their performance.

Maturity Claim: The payment to the policyholder at the end of the stipulated term of the policy.

Maturity date:  The date designated as the date when the policy matures or the date when the policyholder dies.

Mortality change:  The charge for the element of pure insurance pro -tection in a life insurance policy.

Nomination: An act by which the policyholder authorises another per -son to receive the policy monies.

Nominee: Nominee is the person who is nominated to receive the amount under a policy and to give a valid discharge to the insurer on settlement of claim under a life insurance policy.

Non-standard life: Any individual who cannot be granted a policy under normal rates of premium, but can get cover by paying extra premium, is considered a non-standard life.

Occupational hazards: Occupations which expose the insured to greater than normal physical danger by the very nature of the work in which the insured is engaged, and the varying periods of absence from the occupation, due to the disability, that can be expected.

Paid-up value: Paid-up value is the reduced amount of sum assured paid by the insurer in case of discontinuation of the payment of premiums after paying the full premium for the first three years.

Participating policy: A participating policy is also known as a withprofits or par policy. A participating policy charges a higher premi -um than a non-participating policy. In return, the policy owner shares in the life insurance company's divisible surplus, in the form of bonus allotted to the policy. The bonus is allotted in addition to the guaranteed sum assured. This bonus is paid along with the basic sum assured.

Policyholder: The person who owns a life insurance policy, this is usually the insured person, but it may also be a relative of the insured a partnership or a corporation.

Policy period: The period during which a policy contract affords insurance.

Policy year: Period between a policy's anniversary dates.

Policy: The printed document issued to the policyholder by the company stating the terms of the insurance contract.

Policyholder's funds:  Money set aside by insurers to cover outstanding liabilities to policyholders. Also known as technical reserves.

Premium: A specified amount of money that the insurer receives in exchange for its promise to provide the policy proceeds when a specific loss occurs. Premium is the amount paid to secure an insurance policy.

Primary beneficiary: In life insurance the beneficiary designated by the insured as the first to receive policy benefits.

Reinstatement/revival: The process by which an insurer puts back into force a life insurance policy that has been terminated for nonpayment of premiums or a life insurance policy that has been continued as an extended term or reduced paid-up insurance.

Renewal premiums: Premiums that are payable after the initial premium and that are a condition for the continuation of the policy.

Rider: A provision attached to a policy that adds benefits not found in the original policy or that changes the original policy. Riders are additional benefits that one can add to the policy. The rider can be opted for at the time of taking the basic policy. Additional premium is charged for each rider. No bonuses are paid under a rider.

Risk: The chance of injury, damage or loss. The obligation assumed by the insurer when it issues a policy. The spreading of risk across a broad base of the population, adjusted for statistical probability, and the protection against catastrophic loss, is the entire purpose of insurance. For risk assumption purposes, death is viewed as a contingency. That is, although death is certain, its timing is unknown. The process of evaluating and selecting risk is known as underwriting.

Single premium policy: A whole life policy for people who want to buy a policy for a one-time lump sum and then be covered for the rest of their lives without paying any additional premiums.

Suicide clause:  Limitation in life insurance policies to the effect that no death benefits will be paid if the insured commits suicide during a specified initial period, usually the first one year of the policy.

Sum assured: The face amount of a policy payable upon a death or maturity claim. The amount that the insurer agrees to pay on the occurrence of an event-same as insurance cover.

Surrender charge: Fee charged to a policyholder when a life insurance policy or annuity is surrendered for its cash value.

Surrender value: If a policy is surrendered before the maturity date of a policy, the sum that is payable at that point is called the surrender value.

Survival benefit: The payment of sum assured to the insured person which has become due by instalments under a money-back policy.

Term life insurance: A form of life insurance which provides cover -age for a specified period of time and does not build cash value. Term: Term is the period for which insurance coverage is given.

Title:  Transfer of ownership from the assignor to the assignee.

Underwriter: The process of selecting risks for insurance and determining in what amounts and on what terms the insurance company will accept the risk.

Uninsurable risk: That which is not acceptable for insurance due to excessive risk.

Vesting bonus: It is the bonus which the insurance company declares after evaluating its assets and liabilities, and which is added to the sum assured under a policy.

Vesting date: This is the date from which the life assured e.g., child becomes the absolute owner of the policy.

Waiting period: In some types of policies the insurance cover comes into effect some time after the policy is bought. The intervening period is called the waiting period.