Insurance and investment simply don’t mix. Life insurance has absolutely nothing to do with investment. Its only objective is to compensate the loss of income arising out of the death of the breadwinner of a family. If he/she survives the term of the policy, the life insurance policy offers no benefit. They claim they will return the premium after 10 or 20 years, but with inflation that is worth very little.
Insurance companies, have cleverly mixed this essential protection product with investment to create schemes (such as ULIPs & endowment plans) that can only be termed toxic. And millions of Indians have been fooled into buying them (particularly to save on tax), only to regret it in a few months of years. No wonder, persistency of insurance policies is so low.
Why Insurance Doesn’t Mix with Investment
Insurance companies have a pure protection product, which is available at a low cost. For a Rs. 1 crore cover, a 30-year-old non-smoker would only pay around Rs. 12,000 with most private insurers. Insurance companies aren’t content doing selling this policy. It’s just too little money.
This is why they have devised a number of costly products that combine investment with insurance (Insurance vs Investment). Let’s examine why these products are second-rate:
#1. Insurance Sold With Investment is Costly
Those who buy ULIPs are often convinced that they have achieved two objectives for the price of one. This is far from the truth. Insurance companies charge you for both the insurance and investment components of the plan. In a ULIP, for example, the mortality charge tells you how much you are paying to insure yourself. This is a charge, so you don’t earn a return on it, of course. Thus, the insurance component of ULIPs work exactly the same way as a term plan does. That is, in both cases you don’t earn returns on what you pay towards insuring yourself if you do survive the term.
The purpose of buying an insurance plan should be to adequately insure yourself. A term plan can insure you for up to 400 times of the annual premium. Policies that do offer returns at the end of the term, however, do not insure you for more than 30 times the value of the annual premium. The dangerous thing, though, is that people who buy ULIPs are often misled into believing that they are insured.
The reason for this is simple: with most ULIPs, for example, what you receive at the end of the term is either the value of the investment on maturity or the sum assured, whichever is higher. If the sum assured were 400 times the annual premium, the company would find itself paying out much more than you invested every time. With a more manageable maximum sum assured of 30 times, however, the company can be fairly certain that your investment will be worth more than the sum assured on maturity of the policy. Therefore, the value of the investment is all it will ultimately have to pay out.
2. Returns Are Poor
Would you welcome returns of 5% that a traditional endowment policy gives you, OR a long term equity plan that returns a corpus that is twice as much? This is the analysis done (pic below) on popular products. Compare this to equity mutual funds. At the time of writing this, many funds have given as much as 25%+ yearly growth over the last three years! And with ELSS funds (see “Tax Blaster” funds in Jama) you can also save income tax.
If you feel equity funds are somewhat risky for you, then simply for a term plan and invest the rest in PPF. Even that gives much better returns.
3. The Salesman May Be Mis-Selling a Wrong Product
The clever salesman hides his HUGE investment expenses under the guise of insurance cost. A big chunk of it is commissions he gets paid every year till he retires and beyond. So by buying costly insurance products like Unit Linked Insurance Plans (ULIPs), Endowment plans, Money Back plans, you are in fact financing the investment goals of the agents and the like! There are hundreds of combinations of these products that can confuse the common man and the agent steps in offering ‘advice’ which in fact ruins your financial future. What matters is if the product is right for you and more often that is not the case.
Tax savings can be achieved also with Mutual Funds. The specific name is Equity Linked Savings Schemes (ELSS). If you have a recent (3 yrs or before) Insurance policy then check the surrender value and costs if you discontinue it now. Switch to a term plan + equity fund, ELSS or PPF. For a policy closer to maturity, let it fully mature. For extra insurance buy only a term policy.
Be aware if you are being pitched a Hybrid product (one which combines insurance with investments). You neither get a good insurance product nor a good product!
Convenience should not the reason for buying a hybrid product. You can easily buy a term insurance product online. And investments can also be done quite easily online on a direct mutual fund platform, like Jama. If you had to remember only two things out of this article, then it is this:
- Insurance is an expense – keep its cost low.
- Investment is about returns – aim for higher returns. Here too keep commissions low.