You may call it the irony of insurance policies that the payment is received only after an event has occurred against which one seeks protection.

Unless there is an accident or a theft, the owner of a vehicle won’t even get back the premiums that has been paid.

The same rule applies to health and other non-life insurance schemes too. This is well known and yet one seeks “good returns” when it comes to buying life insurance policies.

Life insurance provides financial protection to the family or the dependants of the policyholder in case of the latter’s death or permanent disability.

In search of a “return”, one often overlooks this basic premise and ends up buying less insurance at a higher cost.

Insurance agents also take advantage of this attitude and sell policies which can fetch them higher commissions.

Ground rules

There are two basic reasons for buying a life insurance — to provide financial protection to the family in case the policyholder dies or becomes permanently disable during his/her service period or the certainty of death of the policyholder at whatever age.

The product that meets the first requirement is called term assurance, while the second consideration requires a whole life plan.

Term assurance is least expensive, while a whole life plan is the costliest of all insurance products.

Term assurance costs less because the insurer doesn’t have to pay anything unless the policyholder dies within the policy term.

A whole life plan, on the other hand, costs the most because a payment has to be compulsorily made after the death of the policyholder.

Not many takers

People don’t prefer to buy term assurance because they think that premiums paid for the policy won’t be refunded if nothing happens during the policy term. Insurance agents do not sell them because low premium rates mean they will get less commission.

However, consider this. Suppose, a 30-year-old person plans to buy a whole life policy for Rs 5,00,000. The annual premium that the person will have to pay for 50 years is Rs 11,852, that is Rs 5,92,600 — nearly a lakh more than the sum assured!

Now, if the person buys a term assurance plan from the same insurer, the annual premium will be Rs 1,911 only. However, unless the person dies during the policy term, no money will come back.

In case of an endowment plan (where the annual premium will be Rs 18,909 for a policy term of 25 years), the policyholder will get back the sum assured (Rs 5 lakh) plus any reversionary bonus announced by the insurer even if the policyholder survives the policy term. The rate of bonus will depend on the profitability of the insurer. However, not all insurers declare a bonus every year. The bonus rate is often less than 7 per cent.

Pros and cons

In case of term assurance, the policyholder doesn’t get anything on survival of the policy term. However, if a person invests Rs 16,998 (= Rs 18,909-Rs 1,911) every year in other investment instruments, such as the Public Provident Fund or mutual funds, the return will be more.

Different insurers charge different premium rates for term assurance plans. So, before zeroing in on any particular insurer, one must check the premium rates (see table).

Premium view

The premium rates of term assurance schemes are set to drop because the insurance regulator has reduced the capital ratio that insurers will have to set aside for writing term assurance products. Hence, a reduction in solvency ratio means lower cost of capital for insurers.

Moreover, people’s life expectancy is increasing every decade. The average life expectancy of Indians was 31 years in 1950. It was 64 years in 2006. So, the probability of a 30-year-old person, who had bought a 25-year policy, to die during the policy term was much higher in 1950 than now.

Thus, in case of a term assurance policy, where the insurer will have to pay only if the policyholder dies within the policy term, the cost of payouts for insurers is significantly low. But it is not so in case of an endowment plan because insurers will have to make payouts, whether the policyholder dies within the policy term or survives it.

Rate rap

Interest rate is another factor influencing the cost of generating returns or profits by insurers.

If the interest rates are high, insurers may not be able to reduce their premium rates for endowment and other non-term assurance plans.