Decoding life insurance illustrations

The illustration forms the basis on which reasonable customer expectations are set

A life insurance illustration is an important policyholder protection document. It is a cost-benefit table detailing the premium and expected monetary benefits over time. Insurers must, by law, make you sign an illustration specific to your purchase and not a general document. The illustration forms part of the policy pack. The language of the illustration is technical, and this primer will help you better understand what you have bought.

The illustration is important for insurers as it forms the basis on which reasonable customer expectations are set. These expectations are then built into product pricing. For policyholders, the document clarifies deliverables. An illustration has the following information:

Personal , product details

The illustration mentions the name, date of birth, product, premiums to be paid, rider details and sum assured. Make sure these basics are correct. Insurers have unpaid claims, running into crores of rupees, because they do not have the correct customer contact details. If there are discrepancies, write to the insurer and have these corrected.

In unit-link insurance policies (ULIPs), there will be additional information on funds selected and reduction in yield (explained later).

Guaranteed benefits

There is a tendency for salespersons to communicate expected returns as guaranteed. Sellers may show an illustration and assure you that the amounts written will definitely be paid. That is why the regulator had a column for guaranteed benefits explicitly carved out. ULIPs may not have any guarantees, in which case this section will be excluded. The illustration will list three guaranteed benefits:

On maturity. This is the amount that you will be paid when the insurance completes its term. It does not depend on interest rates or company performance.

On death. The death benefit is different from the maturity amount. This is the amount that will be paid to your nominee if you die. The nominee will be the legal heir you have named in the insurance. However, if you have not named a nominee, all your legal heirs will have a claim on the insurance.

On surrender. Surrender is when you close the insurance mid-term. The amount paid to you has a penalty built in. The penalty is similar to the cancellation fee in an airline ticket. It can be quite high. The penalty depends on the insurance you purchased and the number of years you have had the insurance. The longer you remain in the insurance, the lesser the penalty. The surrender amount mentioned in the guaranteed section is the minimum that you will get.

Returns at 4% and 8%

An important driver of your insurance’s performance is the return earned by the assets that the insurer invests in. A higher investment return will translate into more benefits for policyholders. However, the illustration can only show expected returns. To prevent irrational projections, the regulator has presented two scenarios at 4 per cent and 8 per cent. An insurer can illustrate at lower rates than this, but not higher. An important, less understood, aspect is that the 4 per cent and 8 per cent returns refer to an insurer’s earnings. Policyholders get less because the insurer deducts costs.

This concept is true of all life insurances, but is explicitly spelt out in ULIPs where the illustration has an item called reduction in yield. This reduction is capped by regulation and indicates how much less than the insurer’s returns you will get. The smaller the reduction in yield, the better. Illustrations for ULIPs show the various charges that are deducted from your funds. You need not look at each of these individually because they are all captured in the overall reduction-in-yield number.

Each of these investment return scenarios has information on bonuses, maturity amount and death benefit. A special surrender value is listed. If you close the insurance mid-term, you will be paid the higher of the special surrender value or guaranteed surrender value.

To understand your actual returns in a traditional participating insurance, where bonuses are declared, you have to pull out all the annual cashflows — both premiums paid and money received — from the illustration into an excel sheet and use the internal rate of return (IRR) function to estimate the annualised returns. These tend to be between 3 per cent and 6 per cent per annum for these insurances. The returns are not guaranteed, but depend on the performance of your insurer in terms of managing their costs and investment returns. You can also request your advisor to do this calculation for you as they are well versed in the process.

Also, make sure the illustration in the policy document is what you had originally signed. Spending a few minutes on this document will give a clear view on your life insurance and prevent surprises.

The writer is co-founder,

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