Times of India, 14/3/2011
Alife insurance policy is a key component of a financial plan. Chosen well, it safeguards the financial future of a family if the breadwinner passes away. If, however, it is bought for the wrong reasons, the same policy can become a drain on resources and prevents the policyholder from meeting crucial financial goals. Bangalorebased marketing manager Jitendranath Patri is paying a premium of `1.06 lakh a year for six policies that give him a combined cover of `20.4 lakh. "I feel I have overinvested in insurance. These plans take up a huge chunk of my savings. I must resort to some course correction here," he says.
In Kolkata, Meraj Mubarki is agonising over his inability to save enough for his dream house. "I’m in a financial mess. My insurance policies take up too much of my savings, leaving me with very little for my house," says the 33-yearold college professor.Worse, it leaves this sole breadwinner grossly underinsured. Mubarki is covered for `6.75 lakh, though he needs an insurance of at least `60 lakh.
In Mumbai, software professional Amit Kolambkar is thoroughly miffed with the returns from his Ulips and feels cheated.
"The agent didn’t explain how the plan works and how I can decide my allocation to equity," he says. Getting stuck with an unsuitable insurance policy is a malady as widespread as the common cold. There’s one wrong insurance policy in almost every household.
What do you do if you find that you have the wrong insurance? Escaping from an insurance policy entails a very high cost. You can lose up to 50% of what you have paid. In extreme cases, you might have to forfeit your entire investment.
This is what keeps people from junking a plan, however unsuitable it is. "There is a psychological barrier of losing money, which is why people avoid exiting an insurance policy. But it is better to incur a loss at the initial stage rather than continue and compound the mistake," says Arvind A Rao, chief financial planner, Dreamz Infinite Financial Planners.We look at the options for policyholders who want to junk their insurance plans and explain the circumstances in which each should be exercised.
Let the policy lapse Don’t pay the premium and the policy ends automatically.
This is the easiest way to exit a policy. It is also the costliest if the policy has not completed three years. The premium paid in the first two years is forfeited and the policy ends. You also stand to lose the tax benefits availed of in the first two years on the premium payment. You get nothing, except freedom from the policy. Financial planners say this option should be chosen only if you realise that the policy is grossly unsuitable to your needs. "If the policy doesn’t meet your objective, it is better to let it lapse even though you stand to lose the premium for 1-2 years," says Pankaj Mathpal, managing director, Optima Money Managers. The rule is different for Ulips. Even if it is discontinued after the first year, the policyholder is entitled to some amount after paying surrender charges. However, this sum comes to him only after the lock-in period of five years (three years, if bought before 1 September 2010). The fund value, after imposing all charges and penalties, is frozen in the account and earns 3.5% returns till this period.
Surrender the policy
After three years, an insurance policy fetches a surrender value. If you have paid the premium for three years, your insurance policy would have built a reasonable corpus value. So, if the plan is surrendered after this period, the policyholder can get some money back. It will, however, be a fraction of what he has paid over three years because of the surrender charges levied by the insurer. In the third year, the surrender value is roughly 30% of the total premium paid, but this figure goes down as the term of the policy progresses. Till last year, insurers used to levy very high surrender charges on Ulips in the first three years. But last year, the Irda put a cap on these charges. This is `3,000 or 20% of the annual premium in the first year. For plans with a premium of over `25,000, the cap is higher at `6,000 or 6% of the annual premium. The surrender charges come down progressively to zero in the fifth year. "No surrender charge is levied on policies that are more than five years old," says Tripathy. Surrendering a policy gives you some money back, but it also ends the life cover. So, before you decide to junk your policy, find out if you have enough cover. Also, calculate the cost of a fresh insurance policy at the time. You might discover that the premium is very high because you are older.
Turn it into a paid-up policy Stop paying the premiums, but don’t discontinue the policy.
A better alternative to surrendering your insurance policy and losing the life cover is to turn it into a paid-up policy. As in the case of surrendering it, you can use this option only if you have paid the premium for three years and the policy has built up a minimum corpus. Instead of returning the money to the investor, the insurance company uses it to offer him a life cover. Every year, it deducts mortality charges from the corpus.
However, in case of traditional endowment and money-back plans, this cover is proportionate to the number of years for which the policy was in force. For instance, if a policy offers a life cover of `10 lakh for 20 years and the policyholder converts it into a paid-up plan after five years, the life cover will be reduced to about `5 lakh. On maturity of the plan, the diminished corpus and the accumulated bonus are given to the investor. This feature has been widely exploited by agents to mis-sell Ulips to gullible investors. Last year, the Irda issued new rules for Ulips. If the premium of a plan bought after 1 September 2010 is stopped, the policy will be discontinued.
This is meant to reduce the incidence of mis-selling. The paid-up option is by far the best way to exit an insurance policy because it gives the policyholder the best of both worlds. He is freed from the burden of paying the premium that are a drag on his finances, but continues to enjoy the life insurance cover that was the primary objective of the plan.
Let it continue
If close to maturity, pay the premium till the full term. Of course, if the insurance policy is only 2-3 years away from maturity, one should continue with it for the full term. This is because the painful period of high charges in the initial years has already gone and it doesn’t make sense to let go of the accumulated benefits at the fag end of the term.
If you are finding it difficult to pay the premium, withdraw from the Public Provident Fund or any other longterm investment to pay the premium for your policy. You could also consider taking a loan for this. The Life Insurance Corporation of India, for instance, offers loans against the policy for paying the premium.
We frequently get calls from anxious investor’s who after buying a product are clueless on how much returns they would get, and at times when they want to exit the scheme it becomes a big hardship.
Not just calls, literally on every TV show of ours we get atleast one call on such topics.
Investors need to be Cautious with people who act as “One Medicine Doctor” What ever may be your requirement they would end up giving you only one solution!
Hence you may want to invest for retirement, you may need a protection, you may be trying to save for your children… whatever… A Insurance agent will give you one or more Insurance product for your needs & a Mutual Fund agent will give you one or more Mutual Fund solutions for all your needs!
Hence we repeat… “Play caution when dealing with One Medicine Doctors”
VIVEK KARWA, CFPCM
Investment Strategist & Retirement Planner
Desk Mobile: 98405-40575