What does PAC mean in life insurance?

PAC stands for Premium Allocation Charge. It is an important term to understand when purchasing a life insurance policy, as it can impact your premium amount and the allocation of your funds within the policy. In this comprehensive guide, we will explain what exactly PAC is, how it works, and things to keep in mind about PAC when shopping for life insurance.

Definition of Premium Allocation Charge

Premium Allocation Charge (PAC) refers to a percentage of your first year premium that is deducted by the insurance company before allocating your premium payments towards your policy. This charge covers the insurer’s initial expenses and the commission paid to the agent or intermediary who sold you the policy.

Essentially, PAC allows the insurance company to recover their costs of acquiring new business by deducting a portion of your first premium payment. This ensures they can cover their distribution, marketing, underwriting, and other administrative costs associated with issuing a new policy.

How Premium Allocation Charge Works

When you pay your first premium for a life insurance policy, the full amount does not get credited towards your plan right away. First, the insurance company deducts the PAC percentage from your premium.

For example, if your annual premium is ₹1 lakh and the PAC is 10%, the insurer will deduct ₹10,000 as the allocation charge. Only the remaining ₹90,000 will be allocated towards the fund value/coverage amount as per your policy terms.

The PAC is generally applicable only on the first annual, semi-annual or monthly premium payment. Subsequent premiums are allocated in full after deducting the applicable service tax and cess.

PAC Percentage

The PAC percentage can range anywhere from 0% to as high as 40% for first year premiums. The maximum PAC amount is regulated by IRDAI guidelines.

The exact PAC percentage depends on:

• Type of Policy: PAC charges are higher for policies with high distribution costs like ULIPs compared to traditional plans.

• Premium Payment Term: Single premium policies have a lower PAC compared to regular pay policies.

• Premium Amount: Policies with higher annual premium tend to have a lower PAC percentage.

• Premium Payment Mode: PAC charges are lowest for annual premium payment, higher for semi-annual, and highest for monthly premiums.

• Commission: If the agent commission is higher, the insurer may charge a higher PAC.

• Insurer: Each company decides their own PAC levels based on their business costs and commissions.

Why Insurers Charge PAC

There are a few reasons why insurers deduct PAC from first year premiums:

• Recover Acquisition Costs: The commission paid to agents and other distribution expenses are recovered through the PAC. This cost is highest in the first year when the policy is sold.

• Discourage Early Lapse: The high first year PAC serves as a deterrent for policyholders from discontinuing in the early duration when expenses are still unrecovered.

• Defer Commission Payouts: The insurer can hold back a portion of the agent commission in reserves through the PAC and pay it out over subsequent years.

• Reduce Strain on Reserves: Rather than fully allocate the first premium, the PAC reduces initial strain on the insurer’s finances and reserves requirements.

Overall, the PAC helps ensure the profitability and financial health of the insurance company while providing necessary incentives for expanding business.

Effect of PAC on Policyholders

For policyholders, the PAC essentially means that the full first year premium you pay does not get allocated to your policy fund or sum assured. This can impact your policy in the following ways:

• Lower Fund Value: In ULIPs and investment-oriented plans, charging a PAC on your first premium results in a lower allocation to your fund value.

• Delayed Cover: For protection policies, a higher PAC percentage may mean a slightly lower insurance cover in the first year.

• Loss on Early Surrender: If you surrender your policy in the first year, the high PAC deducted can result in financial loss as the acquisition costs are not fully recovered yet.

• Higher Effective Cost: A high first year PAC can push up the overall effective cost on your policy over the full term.

• Impact on Benefits: Deductions due to PAC may delay the date from which additional perks like loyalty additions or guaranteed bonuses become applicable.

While the PAC does not directly affect subsequent renewal premiums, the lower first year allocation can have a compounding effect on your policy fund value and benefits over the full policy term.

Points to Note About PAC

Here are some important things to keep in mind about Premium Allocation Charges:

• PAC is applicable only on the first annual premium or first installment in case of semi-annual, quarterly or monthly payment modes. Renewal premiums have no PAC deductions.

• Higher premium payment modes like monthly tend to have higher PAC charges compared to yearly payments.

• PAC percentage and amount is clearly specified in the policy document. Read this carefully before purchasing.

• Opting for a lower premium payment term like single pay or limited pay can reduce the impact of PAC.

• Policies with higher annual premiums often have lower PAC percentages, so increasing your premium amount can help reduce the allocation charge.

• Ask your agent for policies that have low PAC and high subsequent premium allocation percentages.

• Avoid surrendering your policy in the first year itself due to the high PAC. Continue paying renewal premiums to recover the cost.

• For short-term goals, opt for term insurance plans which have zero PAC and full premium allocation from first year onwards.

Understanding how the PAC works and factoring it into your premium outlay and overall costs is important to make an informed insurance buying decision.

Examples of PAC in Different Types of Life Insurance Policies

To understand the working of Premium Allocation Charges better, let us take a look at some examples across different policy types:

Term Insurance Plan

Rahul buys a ₹1 crore term insurance plan. The annual premium is ₹10,000.

• Premium Allocation Charge: Nil
• First Year Premium: ₹10,000
• Premium Allocated: ₹10,000 (Full premium as PAC is zero)

Endowment Plan

Ria purchases a 20-year endowment plan for ₹15 lakhs sum assured. The annual premium is ₹1 lakh.

• Premium Allocation Charge: 10%
• First Year Premium: ₹1 lakh
• PAC deducted: 10% of 1 lakh = ₹10,000
• Premium Allocated: ₹1 lakh – ₹10,000 = ₹90,000

ULIP Plan

Karan buys a Unit-Linked plan with annual premium of ₹60,000.

• Premium Allocation Charge: 20%
• First Year Premium: ₹60,000
• PAC deducted: 20% of 60,000 = ₹12,000
• Premium Allocated: ₹60,000 – ₹12,000 = ₹48,000

Pension Plan

Akash purchases a retirement plan. He pays single premium of ₹5 lakhs.

• Premium Allocation Charge: 2%
• Single Premium: ₹5 lakhs
• PAC deducted: 2% of 5 lakhs = ₹10,000
• Premium Allocated: ₹5 lakhs – ₹10,000 = ₹4.9 lakhs

Money-back Policy

Reena buys a 25-year money-back plan paying ₹25,000 annual premium.

• Premium Allocation Charge: 15%
• First Year Premium: ₹25,000
• PAC deducted: 15% of 25,000 = ₹3,750
• Premium Allocated: ₹25,000 – ₹3,750 = ₹21,250

This demonstrates how the PAC percentage and premium allocated can vary across different insurance policy types based on factors like premium payment term, premium amount, etc.

Frequently Asked Questions

How is PAC different from other charges like mortality charges or policy administration charges?

PAC is deducted from the first year’s premium while other charges like mortality, policy admin, fund management charges are deducted on an ongoing basis during the policy term from the fund value. PAC helps cover the insurer’s initial expenses.

Can I get policies with zero PAC?

Yes, term life insurance plans usually have zero PAC. Some insurers also offer traditional endowment or money-back plans with low or no allocation charges.

Does PAC apply on top-up premiums or renewal premiums?

No, PAC deduction applies only on the first annual, semi-annual or monthly installment premium. Top-up premiums and subsequent renewal premiums do not attract any allocation charges.

How can I reduce the impact of high PAC?

Opt for single premium plans,