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Insurance & investment: 2 in 1, it’s a fallacy!

by Money Puzzle   ·  November 1, 2019   ·  

Insurance & investment: 2 in 1, it’s a fallacy!

by Money Puzzle   ·  November 1, 2019   ·  

Photo by Quốc Bảo from Pexels

Have you bought the best investment plan from your local insurance agent? Let me tell you that a decade later you will be regretting the decision as many before you have.

Here is the truth: an insurance policy is not an investment. Why? Because the purpose of the insurance is to ensure that in the event of an eventuality like death of the policy holder, there is a guaranteed sum assured that the holders dependents will get. The objective is to compensate for the loss of income the family suffers due to untimely death of earning members.

But what if it is a 2 in 1? There is insurance for the family and investment? Then its basically too good to be true! One of two things can happen, if there is an insurance attached to an investment like say what the Unit linked plans or ULIPs do, the sum assured (guaranteed) which comes with the insurance will be a paltry sum and the purpose of that money supporting your family is lost. Plus, there are insurance linked mortality costs inbuilt which you will pay the insurer every year from your premium and that amount doesn’t go into your investment fund.

Secondly, say its an endowment or money back plan which promises to give you a fixed amount every few years, while the sum assured may seem sufficient, you will realise that the return you make is also below the regular fixed deposit return for that same period.

I will illustrate both these claims below. Hopefully, that will convince you that there is no such 2-in-1, insurance cum investment bonanza that you can buy.

ULIPs and their insurance fallacy

Let’s say your annual income is around ₹15 lakh, which means a monthly income of ₹1,25,000. Let’s say you decide to invest in an insurance linked investment plan or a ULIP on a monthly basis. You have narrowed down your choice of ULIP and are willing to pay say around ₹15,000 a month. A ₹15,000 monthly premium will get you a ULIP with a sum assured of around ₹18 lakh. So, if something unforeseen were to happen to you, your family will get ₹18,00,000 plus whatever the investment value of the fund is. That’s just about your one year’s salary.

Now, your premium gets invested in a fund of your choice for the insurance you have chosen. There could be anywhere between 3 to 10 different funds to choose from which have varying degrees of debt and equity. Remember a ULIP is also a market linked investment – this means two things:

  1. Don’t be fooled by the expected return calculation you see, the actual returns may or may not follow the same path and are not guaranteed. Plus, the returns showcased don’t consider costs like mortality
  2. There will be some fund management involved and essentially you are paying fund managers with the insurance company to manage your money.

Now let’s see how much of your premium get invested. Here are some of the charges which get deducted from this premium and only the leftover amount gets invested.

Costs in a ULIP

  1. Premium allocation charge – only for the first year
  2. Administrative expenses – monthly
  3. Fund management charge – annual expense which is capped at 1.5% of fund value
  4. Mortality charges – depends on the age, health and sum assured

All these charges are levied before the final unit value is published. Hence, your investment return will be net of these charges. The premium allocation and the mortality charge is deducted even before the investment is made, which means that amount doesn’t get invested at all. The other two are charged as a proportion of the fund value.

There are other charges too like switching costs (for switching between different funds of the same insurer), surrender charges and so on. The insurance regulator has capped the annual charges at 2.25% for the first 10 years of the policy.

The basic point remains this: You get a very low sum assured: a term life insurance policy with a ₹2 crore sum assured at death comes at a monthly premium of ₹1600 (for a 30 year old)!!!

The costs in ULIP like premium allocation and mortality are unrelated to investments and yet you are charged even before your money is invested!!

Endowment plans and their investment fallacy

Let’s say you decided instead that a plan which gives you a fixed amount every few years is better. At least you know beforehand what you will get.

Let’s assume that the policy you (age 30) opt for has a sum assured of ₹50 lakh on death and is a 20-year policy. Your money back schedule will look something like this

After 5 years – age 35 – ₹10 lakh

After 10 years – age 40 – ₹10 lakh

After 15 years – age 45 – ₹10 lakh

After 20 years – age 50 – maturity of policy – ₹61 lakh

Total money back ₹91,00,000

In the interim is there is an untimely death, your dependants will get a minimum benefit of ₹65 lakh (125% of sum assured).

Wow! Looks good doesn’t it? Until you hear the premium amount you need to pay – around ₹3,70,000 a year for 15 years. In 15 years, you would have paid a total of ₹55.5 lakhs! Effectively you make a return of 6% in 20 years!

Clearly this is not the return you chase for a 20-year investment plan!! But unfortunately, this is the return you get for a plan that mixes insurance and investment.

What should you do?

This is simple. Keep insurance and investment separate.

Insure your life with a term plan. You will be pleasantly surprised to see the low cost of term plans. Which means you can get a relatively higher sum assured and death benefit for your family with a very low premium.

The money that you save by doing this, invest for the long term. Now whether you choose a ULIP for this or a mutual fund or pick direct stocks is a choice you will have to make. But if you do take a ULIP remember it is the most expensive investment choice. There are some plans that offer a return of the mortality charges – however, here the premiums are higher for the same sum assured, plus that money spent on mortality charge should have been invested upfront for effectiveness. The advantage of ULIPs is that the proceeds redeemed are tax free. However, if you wish to surrender your policy beforehand due to non-performance of the fund be prepared to pay huge monetary costs which also take up a lot of your time.

This Diwali – make a vow to at least analyse this aspect of insurance before falling for the classic 2 in 1 promise. The advantage simply doesn’t exist!

1 Comment

  1. […] this blog if you want to know […]

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