Life Insurance In Investment Portfolio ?
Investing through life insurance products is very common in India. Investors feel that they are getting something more than a life cover. DSIJ answers the question as to whether life insurance should form a part of your investment portfolio or not
Life insurance or mutual funds—where to invest is the debate that is going on from more than a decade. Both insurance and mutual funds cater to the same class of retail investors who have certain financial goals to achieve and along with it wish to grow the wealth over the long-term. Over the years, both financial instruments have witnessed up and down movements due to market fluctuations and regulations. Things have changed a lot with respect to mutual funds in the last couple of years such as categorisation and rationalisation of the MF schemes, re-introduction of Long-Term Capital Gains (LTCG) tax on mutual funds. From taxation point of view, this change made investment in life insurance more attractive. The sales pitch used to include tax benefits, insurance cover and illustrations stating how investors can achieve their financial goals by investing in life insurance policies, specifically by investing in ULIPs (Unit Linked Insurance Plans). So, does this really hold true? Is life insurance a better product as part of your investment portfolio? Let's find out.
Can life insurance be really termed as investment product?
Do not mix insurance with investment. This piece of advice floats when you come across financial advisers. So, does it really make sense? Yes, indeed it does. Let us first understand what is life insurance as a product and then we would dive into why it is wise to keep investment and insurance separate. Life insurance is a contract between an insurer and policyholder in which insurer guarantees payment of death benefit to the nominees upon death of the policyholder. Simply put, life insurance is an instrument that pays out a sum of money to the nominee on the death of policyholder provided the policy was active. So, the main intent of having a life insurance is to cover the risk of life.
To diversify their offerings, insurance companies started to mix investments with insurance to make it more pleasing for the investors. This actually was the psychological move made by the insurance companies not just in India but across the world.
In the pain vanilla insurance policy, you need to pay the premium and get the insurance cover, but on survival or during the period (provided you are alive) you won't be getting any benefits from the insurance company. This is known as 'term insurance'. Since, no amount was to be given to the policyholder if he remains fit and alive, most of the insured persons thought they were not getting anything out of his policy. Hence, such term insurance policies were not picking up or selling.
So, to increase the sales via making an insurance product more appealing, the insurance companies may have come up with insurance policies that would invest, along with providing life insurance cover. This seems appealing because in the earlier version, you were not getting anything back on survival. However, with the latter, you would be getting monetary benefit even if you are alive. So, is there anything wrong with it? No, not at all, if it provides you better returns than other investment products.
The study
To understand what is better for you, life insurance or other investment products, we have compared it with only mutual funds. There are other investment avenues such as national pension schemes (NPS), PPF, which have been excluded from our study.
In case of life insurance products, we have included ULIPs (specifically multi-cap funds), endowment plans and money back policies. Since investment in insurance is eligible for tax deduction, we have taken ELSS from mutual fund as investment in ELSS allows its investor to avail tax benefit. For all our study, we have assumed two types of investors. Ravi, who firmly believes in insurance as best investment product, while his friend Karan is a fan of mutual funds.
ULIP Vs Mutual Funds
Mutual funds and ULIPs sound similar as both these products are market-linked. However, the biggest difference between them is in terms of product structure and regulations. As far as product structure is concerned, ULIPs despite being a marketlinked product, comes with life cover. On the other hand, mutual funds are also linked to the market, however, there is no life cover whatsoever (except for SIP sure schemes). In regulatory terms, ULIPs being insurance product, comes under IRDAI (Insurance Regulatory and Development Authority of India), whereas mutual funds come under the purview of SEBI (Securities and Exchange Board of India). Following is the illustration to understand whether to invest in ULIP or in mutual fund.
Illustration : There were two friends Ravi and Karan. Ravi believes in investing in ULIP, whereas Karan believes in mutual funds. Ravi bought a ULIP policy with premium of Rs. 10,000, which he pays on a monthly basis. In ULIPs around 3 per cent to 5 per cent of the premium goes towards insurance and the remaining is invested in market-linked funds just like mutual funds. Ravi would get insurance cover of Rs. 12 lakh (10 times of annual premium).
Karan decides to segregate investment and insurance and hence he takes a term insurance of Rs. 12 lakh for which he would pay a premium of Rs. 380 every month and the remaining Rs. 9,620 would be invested in an ELSS fund, which is generating worst return of the category. Here, it is assumed that both Ravi and Karan are 30-year old males, do not consume tobacco and would be investing with an investment horizon of 20 years.
If we look at the above returns, we can say that other than one-year returns, ELSS scores in all other periods, assuming that for the 20-year period, on an average ULIPs would get 8 per cent and ELSS would get 13 per cent (same as 10 year returns). Having said that, Ravi with total investment of Rs. 23.28 lakh at the end of 20 years would end up having Rs. 57.52 lakh and Karan even though has invested Rs. 23 lakh, which is slightly less than Ravi, at the end of 20 years would end up with a whopping Rs. 1.1 crore, which is 91.23 per cent or 52.48 lakh more than Ravi's corpus. Here, we have ignored the LTCG tax for ELSS and costs other than the fund management fees for ULIP. Even if we assume the taxation part, then Karan has to pay LTCG tax of Rs. 10.92 lakh and would end up having post-tax value of Rs. 99.28 lakh, which is still 73 per cent or 41.76 lakh more than Ravi's corpus. Both Karan and Ravi are eligible for deduction under section 80C.
Endowment Vs Mutual Funds
An endowment policy is a life insurance contract designed to pay a lump sum after a specific term or on death. Typical maturities are 10, 15 or 20 years up to a certain age limit. Some policies also pay out in the case of critical illness. There are many people who prefer endowment plans over mutual funds. This can be due to lack of awareness about mutual funds or hard sales done by the life insurance agents. So, with the help of illustration, let us find out which is better: endowment plans or mutual funds? Here also, we have specifically considered ELSS along with term plan for mutual fund investor to make it a fair comparison.
Illustration: In continuance with the ULIP illustration, Ravi decided to stick with insurance as an investment, whereas Karan still believes in mutual funds. This time around, Ravi went on to try an endowment plan with a tenure of 20 years and a sum assured of Rs. 12 lakh for which he needs to pay premium of 70,500 annually. Karan decided to stick with the ELSS. In case of Ravi, he needs to pay the premium annually and would receive sum assured on survival on maturity i.e. 20 years from now. He is also entitled for revisionary bonus on maturity for survival on every policy year completed. We have assumed revisionary bonus of 45 per thousand sum assured or 4.5 per cent (This is the 5 year average revisionary bonus of LIC endowment schemes). So, with this, at the end of 20 years, Ravi receives sum assured of Rs. 12 lakh along with revisionary bonus of Rs. 10.8 lakh. With this, the XIRR comes to around 4.38 per cent.
Now, let's check how Karan's investment does. In case of Karan, he gets the term plan for 20 years with premium of Rs. 4,560 to be paid annually and the remaining Rs. 65,940 to be invested. Assuming that Karan invested in the worst performing ELSS, at the end of the tenure, he is getting Rs. 27.11 lakh post LTCG tax and that turns out to be XIRR of 6.45 per cent, which is 2.07 per cent higher than the endowment policy.
This might not be fair as endowments are not market-linked and usually invest in the money market. So, to make it a fair comparison, we assume that Karan invests Rs. 65,940 in liquid funds. Even after investing in liquid funds, at the end of the tenure, Karan was able to get Rs. 28.26 lakh and XIRR of 6.80 per cent post tax. We have taken the average returns generated by liquid funds to arrive at these returns. Here we can clearly see that mutual funds again score over endowment plans. You can see average returns of the liquid funds are better than the worst performing ELSS.
Money Back Plans vs Mutual Funds
Money back plans are those that pay back a percentage of sum assured to policyholder periodically (ideally every five years) on survival of the policyholder, provided that policy is in force. Money back plans are not market-linked such as ULIPs or mutual funds. However, like endowment plans, these plans have monetary benefits. People usually get attracted towards these schemes as these not only provide you with life cover, but also pay back the money on every surviving period. This seems to be a better deal than mutual funds, right? Let's continue with our illustration.
Illustration: This time Ravi was very anxious and was searching for some better insurance policies to beat Karan's return from mutual funds. So, he came up with money-back policy, which would pay him money back at pre-determined intervals. Here, we have assumed the policy term to be 20 years for which the premium of Rs. 93,700 is paid annually up to 15 years for sum assured of Rs. 12 lakh that gets bonus of 3.9 per cent for every policy year. In this course, Ravi would be getting 20 per cent of sum assured every 5 years of survival and at maturity he will get the remaining 40 per cent of the sum assured along with revisionary bonus. So, Ravi is getting Rs. 2.4 lakh on 5th, 10th and 15th policy year and at maturity he is getting Rs. 14.16 lakh, which also includes bonus of Rs. 9.36 lakh and this brings its XIRR to 4.57 per cent.
On the other hand, Karan is still heading strong with mutual funds and, to make it fair, Karan takes term insurance of Rs. 12 lakh by paying a premium of Rs. 4,560 per year for 20 years and remaining amount of Rs. 89,140 is invested in worst performing ELSS. Karan also withdraws Rs. 2.4 lakh in the 5th, 10th and 15th year. On completion of 20 years, Karan ends up having Rs. 20.00 lakh with XIRR of 7.27 per cent and that too post-tax.
Now you may be wondering this is not a fair comparison. So, to make it fair, we assume that Karan invests Rs. 89,140 in liquid fund. Karan withdraws Rs. 2.4 lakh in 5th year and Rs. 2.41 lakh each in 10th and 15th year. The higher withdrawal in the 10th and 15th year is to adjust for LTCG Karan has to pay. Therefore, at the end of 20 years, Karan ends up with Rs. 16.66 lakh with XIRR of 6.09 per cent post tax. This clearly indicates that mutual funds are better than money back plans as well.
Conclusion
From the above illustration, we can clearly see that mutual funds are a better investment option than life insurance, irrespective of which type of insurance product you chose. So, it is always better not to make life insurance as a part of your investment portfolio. Rather, it is a good idea to segregate life insurance and investment. Let life insurance do its individual job of covering your life and let mutual funds do the job of investing. Even a mutual fund that comes with insurance has its own cons.
However, people who are not disciplined while investing and are way too emotional with the fall in their portfolio value can consider investing in life insurance and make it a part of their investment portfolio. Even people who are already adequately diversified and wish to explore other assets and diversify their portfolio even further can also consider life insurance as an investment option.
However, if we compare life insurance as an investment option with other investments like mutual funds, then it is better not to include life insurance in your investment portfolio.