While Life Insurance is often an obvious part of your investment portfolio, Life Insurance should never be your investment. Here’s why you should never mix insurance and investment.
Insurance is never a good investment. While this statement maybe surprising or most of you may think I am out of my mind; during the course of this post you may understand why I say this. Firstly, let’s understand that I said Insurance is not a good investment; however it should BE a part of your Investment Portfolio. You can read here on why you should actually opt for Life Insurance as your first ‘Investment’ but NOT for monetary gains. Confused? Well don’t be. Let us understand the concept of insurance and investing and why Life Insurance is never ever a good Investment option.
Life Insurance is in principal a way to financially secure your loved ones who survive you when you are no longer around. This is why it should be understood that it is not an Investment that should be made with the purpose of wanting monetary returns while you are alive. Invariably when you opt for a Life Insurance that gives you monetary returns while you are alive, will always provide you lower or insufficient life cover, which will be too little or non-consequential to satisfactorily meet your family’s financial needs after you are gone. Remember Insufficient Insurance is as good as NO Insurance at all. Also the monetary returns that you get from such insurance policies is lower than those you would get if you had invested the same amount of money in regular investment instruments, specially mutual funds. Ideally you should have 10 times your annual income as Life Insurance sum assured. The premium you pay for such a sum assured will be too high to be affordable by a common man who wants a sufficient life cover under any Returns Oriented Insurance Product.
When I say investing in Life Insurance I mean choosing to invest your money in those products that that will give you Life Cover, but also give you monetary returns at the end of maturity. These plans are Endowment Policies, Money Back Plans, ULIPS, and Single Premium Plans. In all these plans if you choose to ‘invest’ or opt for Life Insurance the premium outflow is insanely high and the overall returns you get are next to nothing over a long term. Let us see how:
Mr. A and B both need insurance for Rs. 10 Lac. Mr. A needs returns while Mr. B is happy with pure insurance needs. A opts for Endowment Plan and B goes for a pure Term Insurance Plan. Both are 30 years of age and choose tenure of 25 years. A has to pay a premium of Rs. 38,800 (approx) to get 10 Lac as sum assured while B pays mere Rs. 3,500 (approx.). The difference of about Rs. 35,000 can be invested by Mr. B in other avenues such as PPF, Mutual Funds and even bank FDs, thus giving you returns of at least 9-12% even in the most conservative of scenarios. And equity is always a good choice to invest long term as is in this case- 25 years.
Effectively Low Returns:
Even from tax saving point of view there are ELSS funds and PPF investment is completely tax free. Compared to that the effective returns you would get after 25 years on your endowment policy will be not more that 6-7% at most. You block more money, get less returns. It is not ‘good’ investment. Also how many middle class people can actually afford almost 40,000 a year as premium? Term Plan is their best bet at getting a high sum assured for very little premium paid and thus not being under-insured at affordable rates.
The above illustration holds true even in case of other plans. Though the premium paid may slightly vary from Endowment to ULIP to Money Back plans, the higher premium and lower sum assured ratio will always prevail. The returns on these investment oriented insurance plans are always low. They are expensive and give much lower returns. ULIPs also have high administrative costs that are deducted from the premium you pay and the balance is invested towards the policy. ULIPs are the worst possible products to invest in. However they are the most pushed and marketed products as they are profitable to the company and also for the agent who gets a fat commission for selling these policies. Even the Single Insurance premium plans that give assured returns of 50% over a period of 10 years are actually very low on returns. 50% over a period of 10 years is effective returns of 5% p.a. Your bank FD gives way more than that.
Liquidity Factor and Loss of Insurance:
Also the other factor with Investment is liquidity factor. Life insurance like Endowment, ULIPs, Single Insurance and Money Back Plans have all got long lock in periods. This negates liquidity. When in need of urgent funds, none of these products will be profitable because if you surrender the policy even after the lock-in period is over, the money you receive will be either almost equal or even slightly lower than that of what you have already paid, because of the admin charges etc. deducted. Mutual Funds provide total liquidity and so do FDs. FDs also give you assured returns, even in case of premature withdrawal; you will get pro-rata interest on you FD investment. Mutual Funds can sometimes come with lock-in periods; mainly in ELSS funds and also being market based they may give lower return if withdrawal is made within 2-3 years of investing. But your insurance is not affected if you have opted for Term Pan. Whereas in case of other insurance policies, with the surrender your policy your life insurance also ends and you are no longer assured.
Mixing Insurance and Investment is never a good option. You need to be adequately insured first to be able to be confident that you have taken steps to secure your family’s future. You cannot predict life and death, and even if you have the best of astrologer working out your life span, you never know when something goes wrong. Your family needs to be financially secured in your absence and the only affordable and sensible way to do it is through a pure and simple Term Life Insurance plan. All the fancy policies are effectively giving you low returns as well as insufficient life cover and defeats the purpose of having the insurance in the first place. Also in case you need funds and withdraw prematurely you lose your life insurance as well.
Always, always keep insurance and investments separate. Opt for one Term Plan to cover you up to the age of 65 at least. Rest all your surplus funds should be invested in other ‘proper investment options’ like FDs, PPF, Mutual Funds, Equity etc. Life insurance should be treated as say motor car insurance. Every year you pay the premium, but are happy when you don’t need to claim it. Invest and get insured, but separately even if the insurance agents vouch for the returns and show you all big complex numbers and fancy projections.