Here's why you should never mix insurance with investments

How much insurance do you really need? The answer really depends on who is answering the questions. Financial planners usually bump into two kinds of people, those who have no insurance whatsoever, and then the other kind, who have an active insurance portfolio loaded with endowment plans, money-back policies, unit linked insurance plans (ULIPs) and who also wants to know what additional insurance policy he needs to buy. In fact, the general notion among many people for buying insurance is to get returns.

But, is that right? Absolutely not.

Every aspect associated with assuming return on insurance is incorrect. Of course, there is enough misleading information out there, that make many believe that insurance is actually an investment. But, in reality, it’s not.

Then what is the right form of insurance? In simple words it is a term insurance plan.

What is a term insurance?

• It is a pure life cover ideally taken on the life of the earning member of the family to adequately compensate for monetary losses (present and future) to the family in case of his untimely death.

• It is usually taken for the duration of the working years of an individual to cover his financial responsibilities towards his family.

• At the end of the tenure, there is no return of money (paid as premium or additional return) to the life insured if he survives the term.

• In case an unfortunate event occurs where the insured member dies during the tenure of the policy, the nominee in the term policy gets the Insurance cover amount immediately.

• The premiums which would have been paid for a term insurance policy for the large sum insured would be very nominal.

For years, insurance agents have been patronising the money back and endowment based insurance policies over a term plan for their own vested benefits. More so, insurance has always been sold by people within our close circles that gives rise to malpractices which go unquestioned. Since, insurance has always been sold as an investment by experts of the industry and even the illustrations given to clients give a rosy picture, we fail to see the underlying factors in it which might not be beneficial to us.

Other insurance policies

Money-back policies are basically those which give money at regular intervals (part of your sum assured) and on maturity, give your remaining money back with a paltry addition of amounts in form of bonuses.

Endowment policies give money at the end of tenure, if the life insured survives the term. Usually, the premiums paid in these policies are huge in relation to the sum assured. Also, the tenure for which these policies are sold is also unrealistic.

ULIPs’ returns are linked to the capital markets, be it equity or debt. The mortality (i.e. the life cover) cover in most of these policies is too less and hence defeats the purpose of pure Life insurance.

The average rate of returns on these policies except ULIPs are generally in the range of 4-7 percent on the end of their tenure. This rate of return in today’s times is too low and does not even come close to beating the inflation which hovers around 8 percent.

Why buy a term plan?

• Insurance is a cost. It is not an investment. Like in general insurance of car and home, we do not wait for our assets to be damaged to claim returns from the insurer. Similarly in life insurance, we should not expect returns on our life cover policies.

• Insurance should be equivalent to one’s earnings, age and premium paying capacity. So, it is always advisable to get the required sufficient life cover via a term plan at a reasonable premium. Thus taking a non-term plan would mean burning a hole in your pockets through the hefty premiums being paid.

• Insurance is a monetary compensation for the loss of human earning capacity and so should not be considered an investment avenue.

• Term plan premiums are mostly one-tenth or even lesser of the amount paid to cover the same value of sum assured as compared to the other insurance plans.

Ideally, your insurance requirement should be evaluated considering your financial profile and aligning it with your existing income, assets, liabilities and financial goals.

As the difference in the premium being paid for a sufficient life cover between an endowment policy and a pure term plan is so huge, it is worthwhile looking at the illustration below.

Illustration: Let us consider a male aged 35, who needs to be covered for a sum insured ofRs 50,00,000 for next 25 years. The scenario would be :

(The premium and returns are approximate and could vary)

|
Under Endowment Policy
|
Under Term Policy

Solution : There is a stark difference in the annual premium of the two policies, if the difference i.e. Rs 1,80,000 per annum is invested for the same tenure at a moderate rate of return of 10 percent, the corpus accumulated would be around Rs 1,94,72,717.

If the above model is followed, an additional amount of Rs 84,00,000 can be generated and the life insurance is also adequately covered.

Thus to summarise, we would say that it is prudent to buy a high life cover at a lower premium through a pure term plan and invest the savings ( surplus ) in hand into a higher yield product.

Once the above is done, you do not need a basket of policies in your insurance portfolio, but just a pure term plan which ensures the financial safety for your family adequately.

Kalpesh Ashar is a member of The Financial Planners’ Guild, India and Founder, Full circle Financial Planners & Advisors (a Sebi-Registered Investment Adviser)