You get a share of profits of the insurer, apart from guaranteed benefits
With his first salary credited to his account, Rajesh is wondering whether to go for investment or insurance. Sudhir, his elder brother, suggests him to go for either a participating or a non-participating plan. The two have a conversation on what would be a better fit for Rajesh.
Rajesh: What is the plan you are suggesting for my first investment?
Sudhir: You can have investment and insurance in one product. There are two basic plans to achieve that — a participating plan (par) and a non-participating (non-par) plan. A par plan allows you to receive a share of profits of the insurance company apart from the benefits guaranteed at maturity or on death. The policy will accumulate all the premiums of a policyholder, carve out the insurance portion of the premium and invest the rest. The investment profits are shared with you in the form of dividends or bonuses, reducing future premiums or providing income. A non-par plan will guarantee end-of-term benefits and will not pay any periodic dividends.
Rajesh: The insurance part is fine but what if they don’t make any profits?
Sudhir: The risk is essentially what you are participating in. Insurance companies transfer the risk of returns to the policyholder in par plans while retaining the investment risk in guaranteed benefits plan. Investments made by insurers, whether on account of par or non-par plans, are regulated by IRDAI. Par plans chase higher returns and allocate a higher proportion to equities compared to non-par plans that invest in G-sec/corporate bonds.
Rajesh: Seems like par policies offer more flexibility in structure.
Sudhir: Yes. Par policies offer a choice of fund and movement between funds and tax exemptions including at the time of investment and on maturity. Mind you, unit linked plans (ULIPs) that are quite popular, are also an example of par policies. Non-par policies, on the other hand, are a comparatively simple offering because of their rigid structure compared to par policies.
Rajesh: Because of their equity and return-maximising orientation, par policies would most likely give higher returns?
Sudhir: In capital markets, ‘should expect’ is vastly different from ‘can expect’. You should expect higher returns when assuming higher risk, but returns would still be a function of market performance and manager skill.
Returns from par policies will have a higher correlation with market performance than non-par policies (non-par policies still have to invest in market-linked but low volatility products). Par policies with similar equity exposures have returned 8-15 per cent compared to 5-6.5 per cent for non-par policies in the last 7 years.
Rajesh: Got it. So looks like I would benefit from a par policy?
Sudhir: You can benefit from either, depending on what you are looking to achieve. A non-par policy is for non-negotiable life goals which must be achieved, whatever the market condition, like retirement funding. A par-policy is designed to combine the long duration of insurance investing with better ability to absorb capital market shocks, in delivering above average growth for other non-core goals which can be exposed to market risks.
So, figure out what you looking to achieve and then search for the right product.
Rajesh: Wow, thanks for the detailed explanation. Now I can shop for a more suitable product.
Sudhir: And a large pizza for me.