Economic theory is built on the belief that individuals are very rational when it comes to money and investing. Since every rational economic decision-maker would prefer to avoid a loss, to have benefits greater than costs, to reduce risks and to have an investment that gains value.
Based on this belief, Traditional life insurance is considered as the best mix of the life insurance industry for the majority of customers. As they are specially designed for people who have a low-risk appetite and is looking to build a corpus over the long term for the achievement of life ‘s goals. Earlier, investing in traditional life insurance was thought as a device for achieving the preferred balance between current and future consumption, given the available opportunities for transforming the current capital into future capital. The money paid as the premium was invested in low financial instruments where risk is very low and which provides guaranteed returns to their policyholders. Some of the examples of traditional life insurance products include money-back policy, endowment plans etc. These are called traditional plans because they are the conventional forms of life insurance covers that have been in existence for a long time.
However, even if traditional life insurance had its advantages, there were certain downsides too such as low returns and inflexibility which bought ULIP Life Insurance plans into existence. It got an edge over traditional plans as it provides the policyholder with the opportunity to invest in a number of eligible investments along with the freedom to customize the plan according to their needs. ULIPs are investment product which serves as both an investment and insurance.
To understand the difference more appropriately, here are some of the important features of both the plans:
- Flexibility – It is almost never, ever over-rated
Traditional plans lack flexibility as compared to ULIPs in terms of choice and fund options. ULIPs offer you the flexibility to choose between different fund options such as high equity exposure and allow you to make withdrawals from your fund, provided the fund doesn’t fall below the minimum fund and subject to other conditions. Depending on your risk appetite and market’s performance one can choose between equity and balanced funds. Additionally, you may switch between available funds at any time during the policy term, subject to a minimum switch amount of Rs 2000 or Rs 5000 depending from insurer to insurer. Most people with good knowledge of the market and the investment options available in the market prefer to exercise this option after making an informed decision. However, in a traditional policy, most investment decisions were made by the life insurance companies, where the investment is done primarily in Government Securities and Corporate Bonds. They do not offer the flexibility to its customers to determine how their money should be allocated and what percentage goes to each category. But in ULIPs you do have choices of funds.
2. Transparency is the key
After investing in ULIPs, investors have the option to keep the track of their investment portfolio anytime they want and have detailed notes about the benefits one will get after buying the policy. So, one can regularly intimate regarding the percentage of the premiums that are invested along with the charges levied. Even before investing, the investor knows the charges upfront. This transparency helps the investors to manage their funds accordingly and transfer them if required, to prevent them from any type of losses. But, this type of transparency lacked in traditional life insurance policies as premiums are invested in a common ‘with profit’ funds and therefore tracking is not possible in traditional plans.
- High Return Matters
Traditional policies are aimed to provide guaranteed returns to you or your beneficiaries whether you live until the insurance policy matures or die within the tenure. Nevertheless, even if the returns are guaranteed, these products are suitable for those who have a low risk appetite and are okay with the return that ranges between 3-5%. Also, traditional policies don’t offer much liquidity. However, at the time of maturity, the policyholder gets fund value which is tax-free, plus bonuses.
Investors looking out for high returns in the range of 12-15% should go for ULIPs. In addition to providing protection cover, it is also seen as a tool for wealth generation because of the available options of investing such as bonds and equity – providing opportunities for high returns. However, one must be aware of the risks associated with the capital markets.
Views expressed in this article are the personal views of Ayush Mittal, Head- Investments (Life Insurance), Policybazaar.com.