Insurance
Life insurance is not an investment
Insurance is a key part of every individual’s financial planning but far too many people are thinking of it as an investment
If you consider life insurance an investment, you’re not alone. Permanent life insurance is often sold as an investment wrapped up in an insurance policy, but don’t be too hasty to sign off on the dotted line on a certain product. There may be better options for you, and far better investments. Here’s what you need to know before shopping for life insurance.
Insurance is not Investment. Don’t Mix the Two!
In India, insurance plans that double up as investments are extremely popular. So apart from the life cover that is available during the policy tenure, there are endowment policies that return a lump sum at maturity. Then there are Money-back policies that offer regular payouts at fixed policy intervals and one final payout at maturity. And there are hundreds of variants of these two popular insurance products.
But people buying an endowment plan or a moneyback policy don’t understand that they are not getting the best of both worlds by buying a hybrid product (that combines insurance with investments).
Instead, they are getting a product that is neither a good investment nor a good insurance.
Ofcourse, it is convenient to have just one product that takes care of everything.
But convenience should not result in sacrifice of the very reason why the product is being purchased – returns (for investment) and cover (for insurance).
Isn’t it?
So to put it bluntly, life insurance as an investment tool – is a flawed concept.
Why do people think that insurance and investment are same?
This is the biggest problem.
And the root cause of this problem is the status of tax-saving instrument – which is given to insurance plans.
Ask people about their investments and they will tell you that they invest in insurance!
Common tax treatment is the main reason why people compare insurance with investments and end up buying insurance-based investment products. This is also the reason why people think that once they are done with their tax planning, their financial planning is over too (which is wrong again)
Then there has never been a shortage of our family friend(ly) insurance agents, who have always been over-optimistic about the reason one should purchase insurance – to earn returns and not as protection for dependents.
They will tell you everything about what an insurance policy can do for you – like death benefits, maturity benefits, bonuses, accident riders, etc. But they will never tell you about what would happen, had you simply purchased a term plan and invested rest of the money elsewhere.
(If you don’t understand what I am trying to hint here, don’t worry. I will come to the comparison in a bit. Then it will become crystal clear.)
Don’t mix Investment & Insurance. Why?
Let us take them one by one
When you invest, your main aim is to earn high returns. But when you mix investment with insurance, i.e. you ‘invest’ in insurance products like endowment or moneyback plans, your returns are limited – around 4-6%.
Good equity funds can easily give you 12% kind of returns in the long run. So there is an opportunity cost of not investing in high-return products.
When you buy insurance, your main aim to have a life cover that is big enough to take care of everything (family’s regular expenses for years, major life goals like children’s education & marriage, etc.). But when you mix insurance with investment (like in endowment or moneyback plans), your life cover will be low unless you are ready to pay a hefty premium.
In contrast, pure life insurance policies (term plans) give big covers for very nominal premium.
A small personal example…
When I started earning, I was ‘forced’ to purchase an endowment plan as investment.
And if my memory serves me correctly, it was giving me a cover of Rs 5 lac for an annual premium of around Rs 30,000.
I later dumped that policy. I now have a term plan (one of many), which gives Rs 50 lac cover for about Rs 5000.
To summarize,
Earlier: Rs 5 lac cover – premium Rs 30,000 (traditional insurance policy)
Now: Rs 50 lac cover – premium Rs 5000 (pure insurance policy)
See the difference?
Infact, the ‘family friend’ who forced me to purchase the traditional plan was trying to convince me to create a life insurance based investment strategy! Thank God I realized what it meant – after just few years!
Many people ignore pure insurance plans because it gives no returns if they survive (on maturity).
But we must not forget that life insurance is not there to make us rich when we are alive. It’s to ensure that our dependents don’t become poor when we are not there.
Lets now see exactly why buying a pure insurance product is better than buying a traditional insurance product…
Traditional Life Insurance Policy Vs. Term Plans
For the purpose of illustration, I am taking a popular endowment (+ whole life insurance) plan by LIC named New Jeevan Anand.
Suppose that a person aged 30 years, wishes to purchase an insurance policy with sum Assured of Rs 25 lac for a period of 20 years.
He has the option of either going in for a traditional insurance policy (like endowment plan) or a simple term plan.
The premiums for both policies will ofcourse be different. Lets see ‘how’ big the difference is:
Premium (Endowment Plan) – Rs 1,44,858/-
Premium (Term Plan*) – Rs 3996/-
* LIC eTerm Plan
Surprising. Isn’t it?
The difference in premiums is huge!
Agreed that term plans don’t give back anything in case you survive the policy term. But don’t you think that every year, the term plan leaves you with an additional amount (surplus that you save by not buying endowment plan) that can be invested elsewhere for better returns?
You might argue that endowment plans too offer returns if held till maturity. But returns given by traditional insurance plans are abysmally low – around 4-6%.
Simply speaking, for Rs 1.4 lac that you pay annually as premium, the insurance cover you are getting (Rs 25 lac) is shit inadequate! A simple term can give you same coverage for just Rs 4000.
Whether Rs 25 lac cover is enough for you or not is another question (check this article on how much cover to buy).
But what I am trying to highlight here is the huge difference in premiums.
Infact a cover that is four times larger (than Rs 25 lac cover), i.e. Rs 1 crore can be purchased using term plan at just about Rs 16,000. And this is the premium of term plan offered by LIC (plan name – eTerm). The private life insurers will offer the same cover at even lesser premiums!
Now lets put nail in the coffin of traditional insurance plans
_____
Endowment plan (Rs 25 lac cover) – Rs 1.44 lac annual premium
Term plan (Rs 1 crore cover) – Rs 16,000 annual premium
Annual premium difference – Rs 1.28 lac
Also note that term plan is giving a 4-times larger cover than endowment plan.
Lets see what happens at maturity…
Endowment Plan (at maturity)
Insurance Cover – Rs 25 lacs
Total Premium Paid – Rs 29 lacs (20 years x Rs 1.44 lacs)
Maturity Amount – Rs 50-60 lacs or maybe 70 lacs.
Let us compare this with a combination of Term Plan + Equity Funds (giving 12% annual returns)
Term Plan (at maturity)
Insurance Cover – Rs 1 crore (four times that of endowment plan)
Total Premium Paid – Rs 3.2 lac (20 years x Rs 16,000)
Maturity Amount (from term plan) – Rs 0
Maturity Amount (from equity funds – investing Rs 1.28 lacs annually) – Rs 90+ lacs
So the clear winner in case of maturity amount here is a combination of term plan + equity funds. The amount you get is more than what you would have got had you bought an endowment plan.
Also, you get a life cover that is 4 times larger than that given by the endowment plan. That too at 1/9th the premium.
What else is there to think of now?
Read the above example again (to really understand it)
Now lets come to the case of policyholder dying during the policy term.
Depending on when exactly the death happens, the amount paid to nominee will be equal to sum assured (1.25 times of SA in case of New Jeevan Anand) + accrued bonuses. This would be anywhere between Rs 31 and 60 lacs.
Compare this with term plan – death during policy term will lead to term plan paying out Rs 1 crore to the nominee. In addition, the amount that is already invested in equity funds (in previous years) will also be available for the nominee.
