Never Mix Insurance And Investments

Most people make the common mistake of buying insurance policies with the notion that they also work as financial investments which will fetch good returns. That is certainly not the case, as this article explains

If you ask whether life insurance is a good investment, then the one-word answer for this is a flat ‘No’. Life insurance is not a good investment; rather it is a risk management tool that protects you from any uncertainty with regard to your life, but does not generate handsome returns. Let insurance do the job what it is meant for. This reminds us of a famous dialogue from the movie ‘3 Idiots’ wherein Ranchhodas Chanchad says to his friend Farhan Qureshi, “If the parents of Lata Mangeshkar would have forced her to become a fast bowler and likewise if parents of Sachin Tendulkar would have forced him to become a singer, where would they have been?”

The same thing works with insurance and investments as well. Don’t force your insurance to generate handsome returns, and that too guaranteed. In this article, we will enumerate a few facts as to why you should not mix insurance with investments. And, since we believe in explaining things quantitatively, we would be comparing returns of traditional insurance policies such as endowment and money-back with that of term insurance plus mutual fund investment. Let us begin with one of the most basic questions: how much insurance do you really need? The answer would actually depend on who is answering.

There are usually two kinds of people – those who have no insurance whatsoever and then the other kind who have an active insurance portfolio that is loaded with endowment plans, money-back policies, unit linked insurance plans (ULIP) and who also wants to know what additional insurance policy he needs to buy. The general notion among many people for buying insurance is to get returns. In fact, not able to keep insurance and investment separate is one of the biggest reasons why most people are unable to:

✓ Save enough.
✓ Invest properly and get financial independence.
✓ Have adequate insurance coverage.

In India, insurance plans that double up as investments are extremely popular. Here, apart from the life cover that is available during the policy tenure, there are endowment policies that return a lump sum amount at maturity. Then there are money-back policies that offer regular payouts at fixed policy intervals and one final payout at maturity. And there are hundreds of variants of these two popular insurance products. However, people buying an endowment plan or a money-back policy are unaware that they are not getting the best of both worlds by buying a hybrid product which combines insurance with that of investments.

Instead, they are getting a product that is neither good investment nor good insurance. Definitely, it is more convenient to have just one product that takes care of everything. But it should not result in sacrifice of the very reason why the product is being purchased – returns (in case of investment) and coverage (in case of insurance). Now the argument would be that why at all these insurance policies are more popular and still corner most of the insurance business when compared to traditional policies? The root cause of this problem is the status of tax-saving instrument which is given to insurance plans.

Common tax treatment is the main reason why people compare insurance policies with that of other investments and end up buying insurance-based investment products. This is also the reason why people think that once they are done with their tax planning, their financial planning is over too, which again is a wrong assumption. When you invest somewhere you expect something in return. But this is not true with pure term life insurance. In case of pure term life insurance, if the insured dies, then his or her nominee gets the insured amount.

However, if the insured lives through the policy term, no one gets anything. So then this might lead to you to think: well, if you are not getting anything back, then how does it make sense at all? Ironically, life insurance is not at all about life, it is actually about death. But again, just assume taking a death insurance policy from Death Insurance Corporation of India. How does it sound? Not that pleasant, right? Therefore, it is called as life insurance and hence, should be treated like one.

The Arithmetic

Let us assume that you are buying an endowment policy with a sum assured of Rs 50 lakhs and for a similar sum assured you also have an option to buy a pure term plan. For the endowment policy you need to shed out a premium of Rs 1.54 lakhs every year and in case of term insurance plan, you need to pay Rs 9,000 as premium. This is for a 30-year-old, non-smoker male with 30 years’ policy term. Just to have an idea, we have taken into account policies from Life Insurance Corporation (LIC). And is seen, for the same coverage of Rs 50 lakhs you are paying almost Rs 1.45 lakhs more than a pure term plan .

However, some might argue that in case of endowment plan you are going to receive Rs 50 lakhs plus bonus on maturity. According to the LIC’s latest bonus information, it pays around 4.8 per cent of sum assured as bonus on endowment plan. This seems quite attractive when compared with the pure term plan where you are not getting anything back unless in case of insured’s d eath. But most of the people make a mistake of ignoring Rs 1.45 lakh savings that they can invest in better investment products.

Common tax treatment is the main reason why people compare insurance policies with that of other investments and end up buying insurance-based investment products.

As can be seen from the above graph, in 30 years and on maturity the endowment plan gave you Rs 1.22 crore while Public Provident Fund (PPF) and a good mix of equity and debt portfolio would have given you Rs 1.77 crore and Rs 2.62 crore, respectively.In order to understand returns generated by various investments, including endowment plans, we calculated their extended internal rate of return (XIRR). And the above table clearly shows that the endowment policy miserably fails against PPF and a portfolio of equity and debt. In case of PPF and a portfolio of equity and debt, we have assumed rate of returns of 8 per cent and 10 per cent, respectively.

In order to understand returns generated by various investments, including endowment plans, we calculated their extended internal rate of return (XIRR). And the above table clearly shows that the endowment policy miserably fails against PPF and a portfolio of equity and debt. In case of PPF and a portfolio of equity and debt, we have assumed rate of returns of 8 per cent and 10 per cent, respectively. In fact, the endowment policy was not able to beat PPF, which also a tax-exempt investment avenue.

In our example, at maturity, the endowment policy holder receives Rs 50 lakhs plus the bonus of Rs 72 lakhs. Further, to compare with the endowment plan, we have assumed Rs 50 lakhs pure term plan with Rs 9,000 premium which then we deducted from the amount of premium that you pay for the endowment policy to arrive at the savings of premium i.e. Rs 1.45 lakhs which then is invested in PPF and portfolio of equity and debt. Despite this, buying a pure term plan made more sense than that of opting for an endowment policy.

Conclusion

As is evident from the above analysis, it makes more sense to separate insurance from investment. Therefore, rather than buying traditional insurance policies, opt for pure term plan to save on the premium cost and then invest the saved premium in a good mix of equity and debt to get better risk-adjusted as well as inflation-adjusted returns. Following this strategy would not just help you have adequate life cover at all times but also ensure that you create good amount of wealth over the long term.