Should you invest in insurance related products?

During my recent interaction with officers at different locations, I came to know that many of us have invested our hard earned money in insurance related products. The reasoning given was simple, you get dual benefits i.e your life gets insured and you also get maturity benefits if you survive the policy period. On the face of it, it looks like a good option. But in reality is it? Let’s see.

Let’s first understand the basic concept of life insurance. It is an instrument which provides protection against those risk events which can destroy or diminish the value of human life as an asset. These risk events may be dying too earlyliving too long and living with disability. The Human life Value(HLV) concept considers human life as a kind of property or asset that earns an income.

It thus measures the value of human life based on an individual’s expected net future earnings. Net earnings mean income a person expects to earn each year in future, less the amount he/she would spend on self. Thus, it indicates the economic loss a family would suffer if the wage earner were to die prematurely and accordingly quantum of insurance required would be calculated. In general, we can say that amount of insurance should be around 10 to 15 times one’s annual income. And to cover the risk of life, we need to pay the cost of risk (calculated based on mortality factor) termed as premium.

Now having understood the concept and need of life insurance, let’s see what are the options available to us:

  • Term Insurance. Under term insurance, only the risk of life gets covered without having any maturity benefits on survival. In case of death during the policy period, sum assured is given to the nominee. Premium paid towards the policy  covers only the cost of risk of life.
  • Variants of life insurance policies to cover risk of life as well as provides investment options( e.g endowment, money back policies with conventional investment options and Unit Linked Insurance Plan etc). All such policies provide sum assured in case of death during the policy period and maturity amount on survival. Premium paid towards such policies has two components, firstly, the cost to cover the risk of life and secondly, the invest able portion called as cash value component. Now what you get as maturity value on survival is only the cash value component of the premium with annualised returns of not more than 5-6%.
  • To understand how the finances work at the back end in both cases, let’s take an example of a 28 years old individual seeking life insurance policy primarily to cover the risk of his life for next 20 years with a sum assurance of Rs 2.1 crore(guaranteed returns on death during the policy period)
  • An investment cum life insurance policy( e.g endowment, money back etc) will have an annual premium of Rs 10 lakhs for all the twenty years. Maturity amount on survival, although not guaranteed, is indicated as Rs 4.02 crore assuming 8% annualised returns and Rs 2.56 crore assuming 4% annualised returns during the period of policy(These indicative figures are as per guidelines issued by IRDAI). Mind you, a premium of Rs 2 crore would have been paid by the individual in twenty years.
  • On the other hand, term insurance plan would cost an annual premium of only Rs 11454/- with no maturity benefits. Sum assured in both the cases remain same as Rs 2.1 crore. If the balance amount of Rs 9,88,456 ( difference of premium in both cases per annum) is invested in a index based mutual fund giving say 12% annualised returns for next twenty years, he will have a maturity corpus of Rs 7.12 crore.( Nifty benchmark index fund has given 12.54% annualised returns during last twenty years).
  • Wouldn’t it be better for him to go for term insurance and pay yearly premium of Rs 11454 and invest the saved amount of premium in better investment options? 

Recommendations

  • Life Insurance is only meant to cover the risk of life and not an option for investments. There are much better options available for investments.
  • As a matter of principle, any insurance policy offering maturity value on survival should never be taken.
  • Life insurance policy should always be taken from a known person who can do hand holding in case of requirement. Known registered consultant can understand your requirements and suggest a solution best suited to meet your requirements. Moreover he would be available to the nominee to guide him or her at the time of submitting the claim papers and assist the family to get the claim processed in case of unfortunate death of the policy holder, which will not be the case should you buy your policies from commercial websites like policy bazaar etc.
  • It is a misplaced belief for many of us that there is no commission involved while buying an insurance policy from such sites. Had this been the case, how do you think they run their business and pay hefty fees to film stars for promoting their cause?