Beginner's guide to life insurance & types of LIPs in India 2024

Understanding life insurance and types of life insurance policies is essential to choosing the right coverage that matches your financial needs and goals. To begin with, you must understand that all types of insurance are financial arrangements that provide you protection against financial loss or risk. There are several types of insurance, including health, auto, home, life, and disability insurance, each designed to cover different types of risks. Life insurance specifically provides financial protection to your loved ones in the unfortunate event of your death. 

Let us first understand some basic terms you will encounter when buying a policy and their meaning, before we move on to the various types of life insurance policy available in the market.

What is life insurance

Essentially, you pay a regular premium to an insurance company, and in return, the company promises to pay a specified amount of money (the death benefit) to your beneficiaries if you pass away during the term of the policy. The following is what you need to know:

a) Terminology

> Policy: Policy is the contract that outlines terms and conditions of insurance. It details what the insurer agrees to provide and what your obligations are. This contract is between you, the policyholder, and the insurance company. You need to abide by the terms and conditions to avoid claim rejection.

> Premium: To maintain life insurance coverage you pay the insurance company a regular fee, known as a premium. This is usually paid monthly, quarterly or annually, depending on the terms of the policy. The amount of the premium can be affected by factors such as the policyholder's age, health, type of policy and amount of coverage.

> Beneficiaries: Beneficiaries are the individuals or entities designated to receive the payout from the policy upon the death of the insured person. This can include family members, friends, or charitable organizations as specified by policyholder. If for some reason the primary beneficiary cannot be located at the time of the insured person's death, the benefit will typically be paid to the contingent beneficiary. 

> Death Benefit: This is the amount of money the insurer will pay to the beneficiaries upon the death of the insured person. 

> Coverage: Coverage specifies the events or conditions under which the insurer will pay out a benefit. It may also cover additional scenarios such as critical illness or accidental death benefit, depending on the policy.

> Policy Term: Policy term is the specific period for which the coverage is active. In life insurance, the policy term can be a fixed period or lifetime, depending on the agreement.

> Riders/ Add-ons: These are additional provisions or modifications to a standard insurance policy that enhance coverage or address specific needs.

Types of life insurance in India

In India, life insurance products come in all shapes and forms, each offering different benefits to meet various financial goals and needs of the policy buyer. Here’s a summary of the main types of life insurance policy available:

1. Term insurance

Term insurance is a straightforward and cost-effective way to provide financial protection for a fixed period. Here are its key features:

a) Fixed coverage

Term insurance provides coverage for a fixed period, for example, 10 years or 30 years. Death benefits are paid to beneficiaries if the insured person dies within this period. If you outlive the term, the policy expires. After this, the policy can be renewed. The policy can also be converted to a permanent whole life policy. However, the terms of renewal or conversion will be subject to new premiums and possibly a new medical evaluation.

b) Affordable premiums

Term insurance typically has lower premiums because they do not accumulate cash to create a savings component like whole insurance does. Instead, it only provides coverage for a fixed period, making it an affordable life insurance option.

c) Riders & addons

Term insurance policies can be customized with various riders to enhance the coverage and address specific needs.

d) Level term insurance Vs Decreasing term insurance

Level term insurance and decreasing term insurance are two types of term life insurance policies, each with its own features and benefits. Here’s a comparison to help you understand their differences:

Choosing between level term and decreasing term insurance depends on your specific financial needs and obligations. If you need a stable death benefit amount and can afford slightly higher premiums, level term insurance may be suitable. Conversely, if your financial obligations decrease over time and you prefer lower premiums, decreasing term insurance may be a better fit.

2. Whole life insurance

Whole life insurance is permanent insurance that offers coverage for your entire life, given that premiums are paid timely. Unlike term insurance which offers coverage for a fixed period of time. Here are its key features:

a) Guaranteed death benefit

Whole life insurance ensures that the beneficiaries receive a death benefit regardless of when the insured passes away.

b) Fixed premiums

Premiums are fixed. They can be paid regularly (monthly, quarterly, annually) or as a lump sum. Some policies also offer the option to pay premiums for a limited number of years while maintaining coverage for life.

c) Accumulates cash value

Premiums are typically higher than term insurance due to the lifelong coverage and cash value component. The cash value component represents the part of premium payments that accumulates over time. Here is how policyholders can access cash value in whole life insurance:

> Loans: Policyholders can borrow against the cash value. The loan amount, along with any accrued interest, must be repaid; otherwise, it will be deducted from the death benefit.

> Withdrawals: Partial withdrawals can be made from the cash value. Withdrawals may reduce the death benefit and might be subject to taxation depending on the policy's structure.

> Surrender: If the policyholder decides to cancel the policy before it matures, they may receive the surrender value, which is the cash value minus any applicable charges or penalties.

By accessing this component policyholders can pay premiums, source of funds for emergencies or use it as a supplemental income source in retirement. Though useful, the cash value component adds a layer of complexity to the insurance policy. This motivates people in need of a simple standard policy to opt for term insurance.

3. Endowment plan

Endowment plans are a type of life insurance product that combines life coverage with a savings or investment component, providing a lump sum payout on the survival of the policy term or on death. Here are its key features:

a) Maturity Benefit

If the insured survives the policy term, they receive a lump sum payment at maturity. This includes the sum assured plus any bonuses that have accrued over the policy term.

b) Bonuses

Endowment plans often offer bonuses, which can be declared by the insurance company based on its financial performance. Bonuses increase the overall maturity benefit and death benefit. These may include:

> Reversionary bonuses: Additional amount declared by insurer annually or periodically. It is added to the sum assured and becomes part of the policy’s guaranteed benefits.

> Final bonus: One-time bonus declared by the insurance company at the end of the policy term. Unlike reversionary bonuses, final bonuses are not guaranteed

c) Investment component

Part of the premium is invested by the insurance company to generate returns, which contribute to the cash value of the policy. Policyholders can take loans against the cash value of their endowment policy if needed. They can also surrender it upon early termination of policy and receive the accumulated cash value (minus any applicable charges or penalties).

Endowment plans are suitable for individuals looking for a combination of life insurance and savings. However, endowment plans premiums are typically higher than term insurance due to the dual benefit of insurance and savings.

4. Unit-Linked Insurance Plan (ULIP)

Unit-Linked Insurance Plans (ULIPs) provide life insurance coverage while also allowing you to invest in various market-linked instruments with potential for higher returns (equities, bonds, etc.). Investment risk is borne by the policyholder. Here are its key features:

a) Premium allocation

A portion of the premium is used for life insurance coverage, while the remaining amount is invested in the chosen funds. This feature is flexible and lets you invest across different options according to your risk appetite and financial goals. Following are some popular fund options:

> Equity funds: stocks offer the potential for higher returns but with higher risk.

> Debt funds: bonds and fixed-income securities, provide more stable returns with lower risk.

> Hybrid funds: mix of equity and debt investments, offering a balance between risk and returns

Policyholders can switch between different funds within the ULIP a certain number of times per year without incurring additional charges. Premiums paid towards ULIPs qualify for tax deductions.

b) Net Asset Value (NAV)

Net Asset Value (NAV) represents the per-unit value of the funds in which the policyholder’s investments are allocated. Following is the formula to calculate NAV:

NAV= Total value of all investments - Liabilities/ Total number of units outstanding 

It is typically calculated and published daily by the insurance company or fund manager. It helps determine the current value of the policyholder’s investment in the fund. A higher NAV is generally a positive indicator of investment growth and increased value, but it should not be the sole criterion for evaluating a fund’s performance. 

c) Lock-in period

ULIPs have a lock-in period during which policyholders cannot withdraw their investment. This has been put in place to encourage long-term commitment. The lock-in period may limit access to the invested funds in the short term.

ULIPs may have higher charges compared to traditional insurance products, which can impact overall returns. Investment returns are subject to market risks and can fluctuate based on fund performance.

5. Money back plan

It is a type of endowment plan. In addition to the final maturity, a money-back plan provides periodic payouts at regular intervals to the policyholder. Here are its key features:

a) Regular income

Money-back benefits are designed to provide regular stable financial support to the policyholder during the policy term. The intervals for money-back payouts can vary and are usually specified in the policy terms, such as every 3, 5, or 10 years.

b) Sum assured

The sum assured is the guaranteed amount that the insurer will pay out in case of death during the policy term. This sum is also used as the basis for calculating the money-back payouts.

c) Maturity benefit

At the end of the policy term, if the policyholder survives, they receive a lump sum payment. The final maturity benefit can also include accrued bonuses, depending on the policy terms.

Money-back plans typically have higher premiums compared to term insurance because they offer regular payouts and a savings component. Further, The returns on money-back plans may be lower compared to investment-focused products like Unit-Linked Insurance Plans (ULIPs).

6. Child plan

Child plans in insurance are specially designed financial products that aim to secure the future education and other financial needs of a child. In case of the policyholder's untimely demise, the policy ensures that the child receives the promised benefits and funds for their future needs. Here are its key features:

a) Premium waiver

Premium waiver benefit ensures that if the policyholder passes away, future premiums are waived, but the policy continues, and the child receives the benefits.

b) Wealth accumulation through investment

The plan includes an investment component that helps accumulate funds over time. The returns can be linked to market performance (as in ULIPs) or provide guaranteed returns (as in traditional endowment plans).

c) Maturity benefit

At the end of the policy term, or on the child reaching a certain age, the plan pays out a lump sum amount, which can be used for educational or other expenses. Some plans offer regular payouts at specific intervals during the policy term, providing financial support when needed, such as during critical educational milestones. Participating plans offer bonuses which can enhance the maturity benefit.

Click here to explore various ongoing government schemes for girl child and compare them with child insurance plans to find the best option for your child's future.

7. Retirement plan

A retirement plan is designed to provide income and financial security during retirement. Here are its key features:

a) Stable income

Provides a regular income stream during retirement, helping maintain financial stability and cover living expenses. They achieve this by accumulating a corpus over your working years, which can then be used to provide you with regular income or a lump sum amount upon retirement.

b) Flexible payouts

Annuity and payout options can match individual retirement needs and preferences. Annuity converts a lump sum investment or a series of payments into regular income, which can be received monthly, quarterly, or annually. Following are the common payout options:

> Immediate annuities: Provide regular payouts as soon as the policyholder retires.

> Deferred annuities: Accumulate a corpus over the policy term, which is then used to provide regular income after retirement.

> Systematic withdrawal plans: Allow policyholders to withdraw funds systematically from their accumulated corpus while keeping the remaining invested.

c) Tax benefits

Retirement plans provide potential tax benefits on premiums paid and investment growth. The pension received from annuity plans may be subject to tax as per the applicable income tax laws.

d) Death benefit

In case of the policyholder’s death before or during the retirement phase, the nominee may receive a death benefit, which could be a lump sum or regular payouts depending on the plan.

Retirement plans in life insurance help individuals save and invest for their retirement years.

8. Critical illness plan

Provides coverage for specific critical illnesses such as cancer, heart disease, or stroke.

• Pays a lump sum upon diagnosis of a covered critical illness.
• Can be purchased as a rider or a standalone policy.

Critical illness plan provides financial protection in the event of a diagnosis of a serious illness or medical condition. These plans are intended to cover the high costs associated with critical illnesses and to offer financial support during a challenging time. Here are its key features:

a) Specific illnesses covered

Much similar to pre-existing diseases covered in health insurance, critical illness plans cover a predefined list of serious conditions, such as heart attack, stroke, cancer, kidney failure, and major organ transplants. The list of covered illnesses can vary between insurance providers and policies.

b) Lump sum payout

Upon diagnosis of a covered critical illness, the policy provides a lump sum payout, which is typically a fixed amount or a percentage of the sum assured. This payout is used to cover medical expenses, treatment costs, and other associated financial needs.

c) Diagnosis-based payout

Unlike traditional health insurance, where reimbursement is based on hospitalization and treatment costs, critical illness plans provide a lump sum benefit upon diagnosis of the illness, regardless of hospitalization or treatment expenses.

d) Exclusions and waiting period

Critical illness plans often have exclusions for pre-existing conditions. A waiting period may apply from the date of policy inception before coverage for certain illnesses becomes effective.

Premiums for critical illness plans can be higher compared to basic health insurance due to the comprehensive coverage and lump sum payouts. It's important to review the policy for exclusions, waiting periods, and specific terms related to covered illnesses to ensure adequate coverage. Verify renewal terms and the availability of lifetime coverage to ensure continued protection as you age.

9. Group life insurance

Group life insurance policy is offered by employers or organizations. It is designed to cover a group of individuals under a single insurance contract. Here are its key features:

a) Group premiums

Premiums are usually paid by the employer or group organizer on behalf of the members. In some cases, premiums might be shared between the employer and employees or paid entirely by employees through payroll deductions.

b) Sum assured

Each member of the group receives life insurance coverage with a predetermined sum assured. The sum assured is usually fixed and may be a multiple of the employee’s salary or a standard amount for all members.

c) Simplified underwriting

Group life insurance often requires minimal medical underwriting, making it easier for members to obtain coverage compared to individual life insurance policies.

d) Cost-effective

Group life insurance typically offers lower premiums per member compared to individual life insurance policies due to the bulk coverage provided under a single policy. 

The coverage period is typically aligned with the duration of membership in the group. For example, employees are covered for as long as they are employed by the company.

Conclusion

Each type of life insurance policy in India is tailored to meet specific needs, whether for protection, savings, investment, or retirement planning. It's essential to evaluate your financial goals and needs to choose the most appropriate type of policy. With proper guidance and comparison of various plans, you can screen through the types of life insurance policy and find the one that best suits you. To receive fine-tuned insurance recommendations from OneAssure experts, book a free consultation. Keep yourself updated with more informative blogs on life insurance here.