IN ULIPS, THE INVESTMENT RISK IN INVESTMENT PORTFOLIO IS BORNE BY THE POLICYHOLDER. THE LINKED INSURANCE PRODUCTS DO NOT OFFER ANY LIQUIDITY DURING THE FIRST FIVE YEARS OF THE CONTRACT. THE POLICYHOLDER WILL NOT BE ABLE TO SURRENDER OR WITHDRAW THE MONIES INVESTED IN LINKED INSURANCE PRODUCTS COMPLETELY OR PARTIALLY TILL THE END OF THE FIFTH YEAR.
You pay your premium. The money leaves your account, a receipt lands in your inbox, and you forget about it until the next due date.
Somewhere at the back of your mind, you may picture a locker with your name on it, holding your money until you need it.
Once you know what those jobs are, a lot of things start to make sense. Why a term plan costs so much less than a savings plan? Why you get very little back if you close a policy earlier than usual? Why the insurer asks so many questions before agreeing to cover you?
Depending on the type of plan, your premium may be used for up to four important purposes
● Pile one pays for the risk the insurer is carrying on you this year.
● Pile two pays the Policy servicing expenses, Operational expenses, and Policy administration costs.
● Pile three goes into a reserve, so the money is ready when a claim comes in years from now.
● Pile four gets invested, so there is something to give you at the end. This pile only exists in savings and unit-linked plans.
A pure term plan uses only the first three piles. That is the whole reason it costs lower than other plans.
Job 1: Paying for the Risk
Insurance is a pool. Thousands of people of roughly the same age and health put money in. Sadly, a small number of them will not survive the year. Their families are paid from the pot that everyone contributed to.
The insurer's job is to work out how much each person needs to put in for the maths to work.
Here it is in the simplest form. Say 1,000 people aged 35 each take cover of ₹1 crore. Based on past records, about one of them is expected to pass away during the year. So the pool needs to find ₹1 crore. Split that across 1,000 people and you get roughly ₹10,000 each*.
That example is stripped down and only an illustration. But it is not far off what a healthy 35-year-old actually pays for ₹1 crore of term cover in India.
Insurers use published mortality tables — official records of how many people at each age pass away in a year — and adjust them using their own experience to arrive at the real number.
This slice of your premium is called the mortality charge. It is the reason your age, your health and your habits change what you pay. A 45-year-old is not being punished for being older. The pool she is joining simply has more claims in it.
Job 2: Cost of running the Business
That covers the payment to the bank, agent or broker who advised you. The medical tests and background checks. Printing and issuing the policy. The team who answer your calls. The people who assess claims. And the audit and regulatory work that every insurer must do. Taxes apply as per the law in force at the time.
Here is the bit worth knowing: these costs are not spread evenly across the years. The first year carries far more of them than the tenth.
This is one of the reasons why surrender values may be lower during the early years of some policies. It is not a penalty for changing your mind. It is simply that a large part of your first year's premium was spent setting the policy up, before it had any chance to grow.
Job 3: the Reserve you never see
So a portion of every premium goes into a reserve — money set aside specifically to pay future claims. The amount is calculated by actuaries, the mathematicians who price insurance, and checked independently.
There is a second layer of protection on top.
Job 4: the Money that gets Invested
In a savings plan, part of your premium goes into the insurer's fund and grows over the years. That is what pays you a maturity benefit at the end.
In a unit-linked insurance plan, you can see more of this. After applicable charges, the investible portion of your premium is used to purchase units in the selected funds, each charge is listed separately, and the value moves with the market.
So why is a term plan so much cheaper?
Because it only ever does the first three jobs. And the first job is most of it.
You are buying twelve months of protection at a time, for a set number of years. Nothing is being saved up to hand back to you, so nothing comes back.
People often say they dislike term insurance because you get nothing at the end. That is true in the same way it is true of the rent you paid last year.
If you also want money at the end of the term, that is a different need. It is met by a different kind of plan, at a different price. Both are perfectly reasonable things to want. They are just not the same product.
How to check any of this for yourself?
You do not have to take a blog's word for it. Four documents will tell you most of what you need.
The benefit illustration. You get this before you buy. It shows what you would receive under two assumed rates of return, 4% and 8%, and it separates the amounts that are guaranteed from those that are not.
The sales brochure and the policy document. These set out all the charges, exclusions and conditions in full. For unit-linked plans, every charge is listed line by line.
Read the benefit illustration slowly. It is the single most useful page in the whole pack, and it is the one most people skip.
Over to you
Insurance feels confusing mostly because nobody explains how it works.
There is no locker with your name on it. But there is something better: a shared pool, a reserve built for claims that have not happened yet, a regulator setting a floor on how much the insurer must hold, and rules about where the money can go.
Next time a premium notice arrives, you will know what you are paying for. And when you compare two plans, you will be able to ask a much better question than "which one is affordable?"
You will be able to ask what each premium is actually buying.
If you want to talk any of this through, our team is on 1800 266 8833 between 9:00 am and 7:00 pm, Monday to Saturday.