Do you know that by making an insurance policy your primary investment you end up earning just 5%-6% a year over a 20 year period? In many cases, the return is as low as 4%-4.5%. This is undoubtedly a poor return for such a long period of time. How can that be, given that you were shown return illustrations at 8% a year?
Insurance sellers or agents are allowed by regulation to show you illustrations or calculations of future returns. What they don’t clarify is that the returns shown are assumed returns and not guaranteed or even assured returns. It’s just an example, not what will happen in future. In your provident fund scheme, you know what the rate of interest is today and what you will get each year in the future. While insurance schemes are sold with high conviction, the return you are shown is not as certain or defined, they are assumed.
Why should you doubt these returns which are showcased? Simply because they will never show you the costs. Nothing in life is free, certainly not insurance policies. Would LIC of India have survived for so many decades if they didn’t charge you anything for the policy you are taking? Did you assume it to be a Government owned entity hence the money must come from the Government for its citizens?
Insurance policies, even from LIC, don’t work like that.
There is a definite cost and it comes out of the premium you pay. No agent will disclose this to you, unless you ask them upfront.
The costs for traditional insurance policies with terms like money back and endowment attached to them, are higher than for unit linked plans and term insurance plans. It’s not just one cost, but rather a plethora of costs including your agent’s commission and mortality that gets deducted.
Insurance shouldn’t get mixed with investment
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.
When you are sold a two in one, investment cum insurance, it becomes too good to be true and exciting for you. You think you are somehow beating the system.
Truth is, if an endowment or money back plan 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.
The culprit for this is simply the high costs attached to such policies.
Let’s assume that at age 30, you opt for a policy with 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).
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. Unfortunately, this is the return you get for a plan that mixes insurance and investment.
Term plans plus investment
A better approach is to have low cost term insurance policy as effective life insurance and use the money saved in the premium payments towards pure investment.
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.
What many don’t like about term insurance policies is that you don’t get any money back. But the cost is so low that you will find the advantage in saving on premium expense and starting a long term investment in parallel.
Your long term investment can be made through financial securities like equity mutual funds which also come at a low cost.
Next time an insurance agent comes knocking on your door or a relative who sells LIC policies asks you to help out by buying one, look at it with suspicion. Ask about costs and only when you know what proportion of your premium gets deducted as costs should you proceed.
Repeat the words, insurance is not an investment. The purpose of insurance is to ensure financial stability for your family in case of your untimely death and your investment is what should create wealth for you.
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