Lower premiums or higher benefits for the same cover justify a switch. But watch out for hidden costs.
An unimpressive performance by equity markets in recent months has definitely dampened investor interest in financial products. During such phases, many new tactics are deployed by distributors to sell products. One ploy for unit-linked plans (Ulips) is to ask policy holders to switch the money available in an existing insurance plan to a new (and allegedly better performing) policy. This switch and invest makes sense to a lot of policy holders, as it does not involve investing fresh money in the new product. But, does this practice of replacing a policy in the hope of better investment performance make sense?
Only if there is a well-defined purpose. The decision should come for some tangible benefits at the point of replacement, rather than in the hope of better performance in the future. We discuss some of the merits in replacing a policy.
Lower premium
In cases where a new policy is able to provide the same amount of insurance cover at a lower premium than the existing ones, there is a case to switch. An excellent example if of term plans. Not so long before, the Insurance Regulatory and Development Authority (Irda) reduced the solvency margins on term products, in an attempt to make the latter cheaper and popular. This reduction resulted in the companies passing on the benefits to consumers and slashing the term plan premiums. So, it is now possible to have the same life cover for a lower premium, even if the policy holder is older.
In the adjoining table, the illustration outlines the premiums for individuals aged 25, 30, 35 and 40 years when they first took the term plan five years before, in 2006, before the rates were reduced, for a sum assured of Rs 50 lakh and a term of 25 years. Five years later, in 2011, if these individuals were to replace this policy with another term plan, of the same company, for a sum assured of Rs 50 lakh and a term of 20 years (five years having lapsed since), the premiums are at least 35-45 per cent cheaper, despite getting older.
Increasing competition among insurance companies has resulted in different companies offering cheaper rates for term plans and at the point of replacement, the individual should compare if any better options with other companies are available.
Higher benefits
Likewise, if any policy can give a higher death benefit for the same premium, then there is a case to replace the policy. This would involve a thorough comparison between different companies and selecting the one with the least cost to the policyholder.
Change of policy type
Over the past couple of years, a new variant on term plans have been introduced by quite a few insurers, such as increasing the sum assured at fixed intervals, say, by five or ten per cent yearly. So, young individuals who have recently married and now have children may want to shift their term plans to these increasing sum assured plans, so as to cushion against the increasing responsibilities over the coming years. This shift would not be very expensive.
To illustrate, if an individual had purchased a term plan in 2004, when he was 26 years old, for a sum assured of Rs 25 lakh and a term of 20 years, the annual premium payable would have been Rs 7,000. In 2011, if the same individual, now aged 33, wishes to replace this policy by a term plan with a five per cent yearly increase in sum assured, without any escalation in yearly premium costs, the annual outgo would be Rs 7,700 for the same sum assured and a term of 20 years. This shift only costs 10 per cent more than the previous policy, but assures the individual of a guaranteed increase in sum assured every year over the next 20 years.
Any individual having invested in unit-linked plans who has now crossed age 50 and would like to stay invested in equity plans but wishes to downsize his risk can consider replacing his basic unit-linked policy with the ‘highest Net Asset Value (NAV) guarantee’ fund to limit his risk and exposure to market volatility.
But, some caveats have to be kept in mind before an individual decides to take the plunge. Such as:
Costs involved
The individual has to factor in the various elements of cost, including but not limited to surrender costs on existing insurance policies, entry costs for new policies and higher administrative charges. For the new policy, the insurance company would incur new charges for underwriting, medical tests, commission and so on. Apart from the cost element, the individual would also have to consider some qualitative aspects, such as having to do the paperwork all over again, keeping time aside for getting the medical check ups done and so on.
Habits or health issues
Any new habits/health conditions developed after taking up the policy should also be factored in before deciding on the replacement. Smoking, drinking or adverse health conditions will definitely add to the cost in the new policy. Chances are bright that the revised premiums, after considering these habits/conditions, could be higher than the old one.
Loss of some features
If the old policy had any riders or other benefits, it is possible the new product may not and the individual will have to forgo these. For instance, if the old policy had a ‘critical illness benefit’ as a rider, then at a higher age, the premiums for this rider would be higher than the old one. This could dampen some of the cost savings, as discussed above. It is important to weigh the cost / benefits for replacing a policy, instead of arbitrarily taking a decision. As a rule, however good a new policy or even if the cost savings are high, an individual should never forgo an existing policy before taking up a new one. This could avoid a situation where an individual is left with no cover for a brief while, which could spell a disaster.
The writer is a certified financial planner
