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Why does it not make sense to mix insurance with investment?

This article explains why it is not a good idea to mix insurance with your investments.

04 Dec 2008

In India, life insurance has been sold as a tax-saving product for years. The savings and investment portion has always been on top of the mind - one bought life insurance asking, "What will I get from it?" It has been a quirk of character that allows us all to believe that our lives didn't matter enough to cover the risk of losing it. Hence the value for the risk cover always seemed insignificant.

Moreover, awareness about the actual returns or yields earned on insurance products was quite low. insurance customers solely depended on insurance agents for product information. The agents dumped high premium plans on the clients, ostensibly to provide higher income (it had a lot more to do with higher commissions to the agents) compared to low premium pure insurance plans or term plans. Which would have given exactly the same benefit at a fraction of the cost.

At Apnainsurance, we recommend you do not mix your investments with insurance.

In order that we better understand the cost implications of using your insurance plans as an investment tool, let's look at a realistic, if hypothetical situation:

A 30 year old male purchases an endowment plan for a sum of Rs. 10 lakh for a term of 30 years. He will pay an annual premium of Rs. 29,820. On the other hand, the annual premium for the same sum and duration for a term plan would be Rs. 3,430 - less than 12 per cent of the cost of the endowment plan.

The term plan offers only insurance i.e. no money if the insured survives the term of the policy. The man might argue that he spends all that money and gets nothing in the end. Especially when the endowment plan could provide returns in the range of 6 to 8 per cent per annum. Let us assume the higher return of 8 per cent per annum, which means the insured receives a sum of Rs. 36.5 lakh after 30 years. Keep in mind that in order to earn this 8 per cent per annum return, the insured has to commit an aggregate sum of Rs. 894,600/- to be paid over the next 30 years as insurance premiums.

Now, let's assume the other alternative - he purchases the term plan. His premium is Rs. 3,430/- per annum. He decides to invest the balance 88 per cent of what would have been his annual endowment plan premium (a nice little sum of Rs. 26,390/-) in an Equity Based Tax-Saving mutual fund.

Equity Linked Tax Saving funds have provided returns of 48 per cent over the last one year, 34 per cent over the last three years and around 44 per cent for the last five years. Assuming that the surge in the market will not continue for a very long period, we could look at the returns earned by such funds in the last 6 months. That shows an average return of around 8.44 per cent, translating into an annual 16 per cent return. The insured could actually earn over Rs. 35.5 lakh in 20 years or faster.

So,...which option do you think is the smart one? And what are your feelings about using your insurance as an investment instrument?

The next time you are tempted to use insurance as an investment or saving tool, consider the following:

In your insurance proposal, remove the portion of the premium allotted to the term policy. Now, taking the remaining part of the payable premium, compare the promised yield in the insurance plan to any pure investment instrument. If the investment instrument yields better returns, your answer is clear - get the term insurance and invest the balance of the proposed premium into the investment product.



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