How do whole life insurance policies work?

Whole life insurance policies are unique schemes that offer lifelong cover by paying the premium only for a limited period. Investors can ensure that their insurance needs for whole lifeis covered, and that too by paying premiums for just 15-20 years.

Let us see how whole life insurance plans work and assess their utility.

Whole life plans: A lowdown

A whole life plan has two components--insurance and savings. A part of the premium paid goes towards providing life cover and the balance goes into an investment account. The money in the investment account is invested in a portfolio of largely debt instruments such as government and corporate bonds.

It is a with-profit plan, which means the policyholder gets bonuses as and when the insurance company makes profits. The bonus is paid to the policyholder when it is declared or gets accrued to the fund value. Some insurance companies also offer the option of using the bonus to offset future premiums payable.

Whole life plans are similar to traditional endowment plans. The only difference between them is that in the case of the former, the insurance cover is available for life or up to an age of 100 years, whichever is lower, even if you pay the premium for a limited tenure of 10, 15 or 20 years. In the case of an endowment plan, the insurance cover lasts as long as you pay the premium.

Under whole life plans, the policyholder gets the sum assured plus any bonus accrued either on death or at maturity, i.e., when the policyholder attains the age of 100 years.

In some cases under whole life plans, the policyholder receives part of the sum assured plus any bonus accrued over the premium paying terms at the end of the premium-paying term, and on completion of 100 years of age, he or she receives the remaining sum assured. The premium for such plans is much higher than a normal whole life plan.

For example, a leading private insurer’s plan for a Rs 500,000 cover for a 30-year old with a 20-year premium paying term would cost Rs 12,500, while an endowment plan with whole life option from a top public sector financial institution costs Rs 28,000 a year for a similar cover.

Generally, whole life plans with maturity payment option only at 100 years are cheaper than the endowment plans.

Term life versus Whole life

Whenever discussing a life insurance scheme, it is only pertinent to compare its utility with that of a term plan.

Term plans are pure protection plans, with no allowance for a maturity benefit. Only in case of death of the policyholder during the term of the policy, his or her dependents get the sum assured.

Whole life plans, on the other hand, are hybrid plans with both an insurance cover and an investment component. So, there are both maturity and death benefits available under whole life plans.

Term plans offer cover as long as you pay the premium, while whole life insurance schemes continue to offer insurance cover even after the premium paying term ends.

Significantly, term plans offer much higher cover for the same premium that one would pay in a whole life plan. For example, a 30-year person buying a whole life plan with a 20-year premium paying term may have to pay around Rs 12,500 a year for a cover of Rs 500,000. At the same cost, a term plan can offer insurance cover of up to Rs 1 crore.

Should you buy whole life plan?

The purpose of buying an insurance policy is to provide for a lump sum payment to your dependents in case of your untimely death. Usually, by the time you reach 55-60, you have no financial dependents. Therefore, the moot question is, whether it is necessary to buy an insurance policy that provides cover for a period more than that.

Deciding whether a whole life insurance plan is a smart option or not hinges on the financial situation of the insurance buyer. Generally, a term plan that offers a much bigger cover at lower cost, and at the same time, coverage when your family requires it the most, i.e., when policyholder is between 30 years and 50 years of age, can be a better option.

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