Insurance and Investment
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In India, most Insurance is sold as an investment. But is it really an investment? Is it right for us to consider it thus? If I say 95% of Insurance customers haven’t thought this through, I would probably be right! Having Insurance is extremely important – primarily for the peace of mind it gives us. But it is even more important to ask ourselves this question as to what purpose that policy we take is going to serve.
Lets answer the fundamental question first – Insurance and Investment are two separate things. The reason we take Insurance is for risk coverage – which means it is primarily for our next of kin. Investment is meant for us to earn more on our money and use it for something – preferably while we are alive. See how different they are when you look at it like this? By mixing them both up, we are taking an insurance policy with the idea of spending the returns when the policy matures! That seems rather silly of us when we think it through. Yes, a majority of people who pay for insurance policy live through the term, collect the maturity amount, and spend it themselves before they die. But if we are asked why we took a certain insurance policy, the answer should be to offset some of our income earning potential in case of a premature death, so the family doesn’t have to struggle with finances in addition to the tragedy of losing a loved one.
Till a couple of decades ago, there was only one kind of insurance – life insurance, from LIC. All the others were general insurance companies dealing with automobile, fire, theft, health etc. Most people would take a policy and pay for the premium out of their salaries directly. Sum assured would be computed with very low interest rate, but people would have a policy for the sake of risk coverage. These policies were called traditional policies or endowment policies. After the insurance industry opened up and foreign players entered the market (with an Indian partner as mandated by law), newer options started coming in. To their credit, LIC also changed rather rapidly and managed to maintain their position of leadership by offering these newer kinds of products. The concept of ULIP – Unit Linked Insurance Plan – became the rage, and there started the problem of misrepresenting insurance and selling it to millions of gullible people who really didn’t know what they were getting into. Like with the roadside kiosks set up to dispense credit cards, and like real estate agents knocking on doors on Sundays, insurance policies started getting sold by the truckload. While the actual statistics are difficult to obtain, it is safe to say that a large percentage of these people who got into ULIPs without being properly informed would have dropped out midway, leaving that money to the insurance companies – much like the paid premiums on lakhs of LIC policies of yore that became company property.
Lets get back to our theme of the article. Conceptually, a ULIP is a combination of an insurance policy and an investment product. It is quite good when explained to us. But there are certain challenges to it – the term of these products is longer than that of typical investment products. For most policies, it is a lock in of 5 years, before which if you discontinue paying the premiums, the policy lapses. Then there is mortality charge that is applied every month, making the amount which is actually invested in a mutual fund significantly lower than what you paid for it. In fact, in the initial years of ULIPs, the first year, as much as 25% of the premium paid would go towards charges, second year would be 20%, and so on. So the amount invested is not actually an investment, but it is like a term policy you’re taking for risk coverage. That fact was seldom disclosed to customers – which is why the term misrepresentation has been used. Earlier, paper statements would come periodically and most of us would just glance and throw it aside, not understand the charges applied. Today, for most good policies, those charges have been done away with, and while mortality charges are mandatory, they’ve become quite reasonable. But we should understand that still a portion of the money we pay goes towards maintaining our risk coverage.
So lets ask ourselves – are we taking a risk coverage product or an investment product? Like we spoke in the beginning of this post, the purpose of both is as different as chalk and cheese! It is good to have a combination of both, but if you’re buying an insurance product, by definition, the primary purpose of it is risk coverage. By default, a comparable mutual fund run by the same fund house would earn higher returns if invested directly since 100% of the money you put in would go towards allocation of units.
Lets approach this scientifically. What is your ideal risk coverage? That would depend on your age, salary, savings, and other factors, and there are decent calculators available for free online which will allow you to ascertain your ideal insurance amount. Lets say you want an insurance cover of ₹ 50 lakhs or 1 crore. With the options we have available to us today, the best option would be to take a term insurance product for that sum as coverage, and be done with it. Most term insurance products don’t give you anything in return if you’re alive by the end of the term, but the premiums will be many times lower than what we would otherwise pay for a normal policy. Plus there is tax benefit. There are some term policies which return the money you pay at the end of term also, but they charge a higher premium. There is no appreciation of capital in this, but that’s not the purpose behind an insurance product, is it? Then use up the remaining money to buy into a closed-end investment product and you’ll almost always earn more in these products than in a ULIP.
So does that mean all ULIPs are useless? NO!!! If you play your cards right, you can get the best of both worlds, here’s how. Almost all insurance companies today have products which have 100% of your premiums available to load into units. The mortality charges they deduct for the first few years is often added back into your premium paid at the end of the guaranteed term – say 5 or 10 years – as you have chosen while filling out your form. That’s why we said ‘if you do it right’. Don’t let an advisor sway you. Be smart – read up. It is not rocket science. Choose a product from a company you trust, with the above mentioned features. And then choose the maximum term permissible as age of the policy. So you can choose to pay for 5 or 10 years, but keep the policy active till the age of 80 or even 100! See what I mean? Smart. After 5 years, even if you don’t pay, all benefits of the policy will continue. If you want to pay, even better – your sum assured will keep rising. After the minimum term, you can freely withdraw money or even close the policy if you wish. Here is the big benefit – insurance returns are tax free in India currently on completion of payment term. So though the money is being invested in the market, you don’t have to pay STCG or LTCG on it since the product is classified as an insurance policy and not as an investment product. Plus annual premium of upto ₹1,50,000 can be used to claim benefit under section 80 (C). And ofcourse if something happens to the policy holder, the family gets the full benefit under risk coverage. Many policies have a clause of debilitating illness wherein if one of the diseases or disabilities mentioned on the policy were to unfortunately happen, the full amount would be disbursed. One more thing – for a policy with investment features, prefer to pay quarterly and not annually – since the NAV of the fund would get averaged out.
Lets sum it up then – ask yourself whether you are taking an insurance product or are investing for the future. If you already have enough insurance, it may make more sense to directly invest rather than go through an insurance product. If you don’t have enough insurance cover, get a term policy. If you want to take the ULIP route, it should be because you still have tax savings unused, and so that the tax-free returns can be enjoyed on the full sum assured along with accrued bonuses. And most importantly, do not blindly listen to your advisor or your banker or some advertisement. Insurance is a long term commitment. Getting out of it prematurely will mean you lose your paid premium. Read up on available options, or if you need more advice, feel free to reach out to us via any of our Social Media accounts – Twitter, Facebook, Quora.
