Understanding Life Insurance: Benefit Charge Explained

Life insurance is a crucial part of financial planning, offering peace of mind and financial protection for loved ones in the event of an unexpected death. While it is an essential investment for many, it's important to be aware of the various charges and fees associated with life insurance policies, as these can impact investment returns. These charges are typically not openly communicated and can shrink the investable portion of the premium paid. Understanding these fees is crucial for making smart choices and ensuring your funds are not reduced by unnecessary expenses.

Premium sum allocation charges

For example, if the premium allocation charges are 12% on a premium of Rs.1 lakh under a ULIP, the insurance company will charge Rs.12,000, leaving a balance of Rs.88,000 for further allocation. A portion of this balance will be used to provide life insurance, while the remaining will be invested in market-linked products to grow the money.

Premium allocation charges are typically higher in the first year of the policy and may be charged for a limited number of years, such as 5-7 years. They are also different for single premium plans and regular premium plans. It's important to note that these charges are separate from other fees associated with life insurance policies, such as surrender or discontinuance charges, mortality charges, fund management charges, and policy administration charges.

Understanding premium sum allocation charges is crucial for competent investors. These charges directly impact the investible part of the premium sum paid. By being aware of these charges, individuals can make informed decisions, maximise their investments, and ensure their funds are not reduced due to unnecessary expenses.

Surrender or discontinuance charges

Surrender charges can apply for as little as 30 days or as long as 15 years on some annuity and insurance products. For life insurance policies like annuity plans, the discontinuance charge is about 10% of the funds contributed to the contract within the first year, then it drops to around 1% in subsequent years. Surrender charges typically start high in the first few years of the policy and gradually decrease each year until they reach zero, usually in the 10th year of the policy and beyond.

In the case of mutual funds, short-term surrender charges can apply if a buyer sells the investment within 30, 60, or 90 days. Surrender charges are designed to discourage people from using an investment as a short-term trade. Surrender charges are implemented to recoup some of the insurer's initial costs and discourage early policy termination, ensuring financial stability for the insurance company.

Mortality charges

A mortality charge is a fee levied by insurance companies to provide life coverage to the policyholder. It is also known as the "cost of insurance" and is usually a small amount. The mortality charge is based on the insured's age, gender, and health, and it is intended to compensate the insurer if the insured does not live to a certain estimated age.

In the context of ULIPs (Unit Linked Insurance Plans), the mortality charge is levied to cover the risk of providing life cover to the insured in case of unexpected demise. The charge is based on the "sum at risk," which is the amount the insurer has to pay out of pocket in the event of the insured's death. The sum at risk is calculated as the sum assured minus the fund value, and the charge decreases as the fund value increases during the policy term.

Fund management charges

Under ULIPs, part of the premium paid goes towards life cover, while the remaining amount is invested in various funds such as equity, debt, or balanced funds. The management of these funds attracts a fee called fund management charges. These charges vary across insurance companies, but the regulator IRDA (Insurance Regulatory and Development Authority) has set a cap of 1.35% per year on these charges. The fund management charge for debt funds is typically higher than that of equity funds.

It is important for potential investors to understand the various charges associated with ULIPs to make informed investment decisions. While ULIPs offer the advantage of combining investment and insurance, the charges can significantly affect the overall returns. Therefore, investors should carefully consider these charges before deciding if a ULIP is the right investment vehicle for their financial objectives.

Insurance policy administration charges

The charges are intended to cover the costs of record-keeping and other administrative tasks. Some of these charges are universal, such as initiation or termination fees. However, additional charges may arise if a policyholder has a significant life event (e.g. marriage, change of job, or moving house) mid-policy and wants their coverage updated.

Policy administration charges are an integral part of the operational maintenance of life insurance policies, and they ensure the provision of necessary services and management.

Frequently asked questions