Do Not Mix Investment & Insurance

Some time back, a reader informed us why pure life insurance goes against his religious beliefs.

According to him, it works like a betting game. Let's say you insure yourself for Rs. 10 lakh at an annual premium of just Rs 2,000. What it means, according to our reader, is that you are willing to bet that you would die this year and so willingly cough up Rs 2,000. The insurance company bets that you will not die and is willing to pay your family Rs 10 lakh if you do. If you survive - which, we're sure, you would really love to - you lose the bet and the insurance company walks away with Rs 2,000. If you win the bet, you know what happens.

This bet goes on over a period of 10, 15 or 20 years, whatever the term of the policy. And so, he concluded, that it goes against his faith to lay a wager on his life. That forced him to arrive at the conclusion that a policy which gave him a return would be a good option because he could view it more as an investment.

Well put, undoubtedly. But not a wise conclusion.

Insurance is not an investment

When you put your money somewhere, you expect something back. Not so with pure term insurance. If you die, your nominee gets something. If you live, no one gets anything. Now that may sound like a raw deal. But, hey, that's what life insurance is all about. Ironic as it may appear, life insurance is not about life but about death.

In their bid to get something out of the money given to the insurance company, investors opt for insurance policies that give you 'something back' even if you do live. And, in the bargain, give pure term insurance policies the cold shoulder. While everyone is entitled to their own personal views, we are of the opinion that term insurance is the purest, cheapest and best form life insurance.

The math behind it

Let's assume a profile.

Age: 30-year old male

Life cover: Rs 1 crore

Tenure: 20 years.

Now let's look at the Super Savings Plan from the same company. Here, in the event of death, the beneficiary will get the sum assured of Rs 1 crore. Also, if the insured person outlives the policy, he will get the sum assured plus bonuses at the end of the policy term. In addition to the sum assured, depending on its performance, the company pays a simple reversionary, interim bonus and terminal bonus. Please note, these are not guaranteed payments. However, the person will have to pay an annual premium of Rs 5,57,368 for a Rs 1 crore cover in this policy.

If he had taken a basic term policy with an annual premium of Rs 8721, he could have invested the balance amount of Rs 5,48,647 (Rs 5,57,368 minus Rs 8,721) in an investment of his choice.

Let's say he invested Rs 45,720 (5,48,647/12) every month for 20 years via a Systematic Investment Plan (SIP) in Franklin India Prima Plus Fund. At the end of 20 years, he would have made over Rs 19 crore. Yes, the fund has given an annual return of 22.39 per cent in the last 20 years. Even at 12 per cent annual return, he would have made Rs 4.21 crore after 20 years. An endowment plan like Super Savings Plan would pay him only Rs 1.78 crore (Sum assured of Rs 1 crore plus an assumed bonus of Rs 78 lakhs). As you can see, it is really lower than what he would have got had he separated his insurance and investment needs. Let's look at another type of term insurance policy which is not an investment option but one that only returns premiums.

A basic term insurance policy from SBI Life known as Smart Shield- will have an annual premium of Rs 11,925. But SwadhanPlus, a term insurance policy with a guaranteed refund of the premium paid on survival at the end of the policy term, has a premium of Rs 61,800 for the same cover.

So at the end of 20 years, he would get the premium returned to him. This will amount to Rs 12.36 lakhs (Rs 61,800 x 20 years). Once again, let's take the difference in the two premiums which amounts to Rs 49,875 (Rs 61,800 minus Rs 11,925). If he had invested Rs 4,156 (Rs 49,875/12) every month via a SIP in an equity mutual fund scheme, he would have got Rs 38.23 lakh on maturity, assuming a conservative 12% return. So instead of getting Rs 12.36 lakhs at the end of 20 years, he could have still had an insurance cover and beaten the return on life insurance policy by investing the balance.

How insurance companies operate

The entire amount you pay to the insurance company is not what is invested. The premium you pay has three components.

Expenses (including commissions earned by the agents as well as expenses and distribution costs).

Mortality premium

Investment amount

And, to top it all, the amount permitted to be invested in equity may just be around 8 to 10 per cent of the total investment. So one cannot really expect a great return from their insurance product.

Moreover, the money may sound good now but may not be that great when you finally get it. Let's say you are promised Rs 2 crore 20 years down the road. Taking inflation at 8 per cent per annum, that would be worth around Rs 42 lakhs in today's prices.

Getting underinsured

The problem with money back polices is that the premium is much higher and one may end up getting underinsured.

Say, you are a 25-year-old male looking for a life cover of Rs 1 crore for 30 years. If you took the Shield cover - the premium would be Rs 12,250 per annum.

But, not comfortable with the premiums being 'lost,' you opt for Swadhan plus. Now, the premium goes up to Rs 42,600 for the same cover.

If you cannot afford Rs 42,600, you might be tempted to go for a policy of only Rs 50 lakh that would cost Rs 21,300 a year. So in one stroke, you have halved your life's financial worth!

Commissions motive

Each insurance product has its own commission specifications. But the trend is that in the first year, the agent's commission is the highest. It decreases for the next three years and after that drops even more. In the very first year, your agent will get around 15 per cent to 45 per cent of your premium as commission. In the following three years, it will drop to between 5 and 15 per cent. After that, it will be between 2.5 and 7.5 per cent.

Generally, the upfront commission (amount paid in the first year) is the highest and then the trailing commissions are much less. So the higher the premium you pay, the more the agent benefits.

For starters, don't expect an agent to even mention term insurance. He will immediately go for the fancier options. Commissions are his bread and butter and he will try and sell you one that benefits him.

Secondly, don't blindly trust your agent. He has his own interests in mind. He will do his best to convince you why you need a particular product. As one of our colleagues keeps saying that life insurance is never bought, but always sold. So make sure you are not being sold a policy but are smartly buying one.

Finally, now that you know how much an agent earns, maybe you could consider becoming one.