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Unpleasant Facts about Investing in INSURanCE PLANS

Unpleasant Facts about Investing in INSURANCE PLANS: Secrets Revealed!

Since I’m into Personal Finance Management for quite a long time, an old friend of mine who’s a Software techie suddenly showed up from somewhere and asked me, “Hey pal, how are you?!”

And I said, “Yeah man, I’m great. How are you doing?”

Then he put forth the real question, “Buddy, I have invested in an insurance plan recently. What do you think about it, is it good or what?”

I was stuck for just a moment, “Whaaat..? You invested in an insurance plan?!”…in a second I got what he meant and asked him back, “Oh! Do you mean an Endowment policy?”

He then said, “Yeah yeah yeahh., that’s the one, endowment policy”

This is how the conversation began and what continues in this article is the arranged abstract of personal advice that I gave my friend.

1. A Common Misunderstanding

The very first thing I told my friend then and what I want to tell you now is the same,

“My dear friend – Insurance is not an Investment”.

This is not a misconception that only my friend has. I recognized that many people are also confused with the idea of insurance as an investment, which is not. The main reason for creating this article is to bring clarity among investors and individuals who are wasting their hard-earned money by investing in insurance policies.

I’m sorry if your insurance policy agent made you believe that insurance is an investment. But, it doesn’t work that way. However, insurance policies and investment schemes are combined together to come up with fusion plans like Traditional plans and ULIPs.
Common Misunderstanding[Note: To avoid confusion – the phrase ‘INSURANCE INVESTMENTS’ used in this article denotes traditional plans like Endowment plan, money back plan, and ULIPs which are a combination of insurance and investment]

An Endowment insurance plan and Money back plan are what we typically call a Traditional Plan, and ULIP is abbreviated as Units Linked Insurance Plan. These insurance investment plans are said to be a combination of insurance and investment but they are neither a good insurance nor a good investment.

Let’s make one point clear, insurance and investment are to secure and create wealth for an investor, not to make a commission agent rich! But the insurance plans are more intended to be desired by the agents and not by investor.

Before we get to know why is it a bad idea to invest in traditional plans, we will see what the phrases insurance, investment, term insurance, traditional plan, and ULIPs actually mean.

2. What do these actually mean?

The actual definition and purpose of the important phrases we are about to discuss are described here.

    a) Investment
    b) Insurance
    c) Term Insurance
    d) Traditional Plan (Endowment Plan)
    e) ULIPs

a) What is an Investment?

An investment can be defined as the use of money to purchase an asset (physical/paper) in expectation to sell it for a higher profit in the future.

Example: Ajay buys a security from the share market at ₹ 300 today and expects to sell the security at ₹ 400 after one year. This process is called as an investment. You are investing in the share market to make ₹ 400 with ₹ 300 in a year.

Investment is used to make more money in the future with the amount of money you already have now.

b) What is Insurance?

Insurance is an agreement between an individual and an insurance company in which a specific premium is paid to the insurance company and in return, the company will provide compensation for a specific loss/damage/illness/death incurred by the individual.

In simple, insurance is a promise to provide compensation against a possible eventuality. How much life cover you need depends on your annual earnings, expense, your dependents, and debts. If you want a high life cover you have to pay a higher premium and for a lower premium, you get a lesser life cover.

Example: You know what happens with your car insurance. You pay a car insurance premium every year, and you can get compensation for your loss if your car is damaged or theft.

Insurance is basically used to get protection against a financial loss. But there are many insurance myths that you could have come across which could only cause confusions.

The best example that fits for a Life insurance plan is a Term Insurance plan.

c) What is a Term Insurance plan?

A Term insurance plan is a pure life insurance policy in which a person is insured for a specific period of time (term). If the insured person dies within the specified term, the insurance company will pay the promised amount to the family.

How a term plan works is given with an example below.

Example: Let’s say Ajay has a Term Insurance plan of ₹ 1 Crore for a tenure period of 30 years and pays an annual premium of ₹ 8,765.

In case Ajay dies within the tenure of 30 years, then Ajay’s family will get an amount of ₹ 1 Crore as compensation from the insurance company.

In case Ajay dies after the tenure of 30 years, then Ajay’s family will not get any money/compensation.

Term insurance is basically used to give financial protection to your family after your untimely demise (within the specified term period).

d) What is a Traditional/Endowment plan?

A traditional plan (endowment/money back) is a combination of a Life Insurance plan and a savings plan (often saving is promoted as an investment but is not). Along with the life cover provided on the demise of the insured person during the tenure, an endowment plan also provides an additional bonus on maturity if the insured person survives.

The endowment plan works like this – if the insured person dies within tenure, the nominee of the insured person gets the sum assured as a death benefit. If the insured person survives the tenure then he gets the sum assured plus an additional bonus.

Example: Ajay buys an endowment plan which assures ₹ 5 Lakh on maturity for an annual premium of ₹ 23,500 for a tenure of 20 years. Ajay will get the assured sum on maturity regardless of his survival or demise.

If Ajay survives the tenure, he will get the sum assured along with an additional bonus.

A loan can also be availed against the endowment plans until a limited amount. This is a facility to enable liquidity of the funds.

e) What is ULIP?

ULIP is abbreviated as Units Linked Insurance Plan which is a combination of Life insurance plan and Investment. The policyholder pays a premium amount and a part of it goes to insurance and a part of the money is invested in instruments like equity, debt, or balanced.

If the insured person dies during the tenure, then his family will receive the sum assured or the NAV of the investments whichever is higher. If the insured person survives the tenure, then he receives the NAV of his investments which would be around 6-8% return.

Example: Ajay chooses to invest in a ULIP plan with an annual premium of ₹ 25,000 for a tenure of 20 years which promises to give sum assured of ₹ 5,00,000 or the NAV whichever is higher to Ajay’s family in case of his demise during tenure.

If Ajay survives the tenure, then he will receive the NAV of the funds in which the policy invested not the sum assured.

I hope this section has given enough clarity about the difference between the concept of insurance and investment and the difference between the plans endowment, ULIP and term policy.

3. The cause of Confusion between insurance & investment

The basic reason seems to be the ignorance of investment and insurance. Gathering enough knowledge about investments and insurance could easily remove ignorance.

One main reason for people being ignorant is the insurance agents who are not concerned about their client’s wellness but are only concerned about their commission charges.

Insurance

If you have decided to get insured and consult with a few insurance agents, you will find that almost all of them would promote a traditional plan more and not pure term insurance. This is not because they care about your wellness but selling a traditional plan earns them a bulk commission income.

Another reason for this confusion is the tax treatment. Since insurance plans are given tax exemption, it becomes easier for the insurance agents to promote the endowment plans. The tax treatment appears to be attractive to people and thus they choose to invest in insurance plans!

If you ask how to become enlightened about insurance and investment, then the only answer would be to research about everything and compare the numbers to find the one that can benefit you – which is what we have done in this article.

4. Why you should not Invest in Insurance?

You know when scientists created a Liger which is the hybrid of a Lion and a Tiger, it was something really unique. But it was not as fierce as a lonely tiger and not as majestic as King of the Jungle. It was just a showpiece that had debilitating health problems and often premature death. The same happens to be the case of traditional plans. The whole idea of insurance as an investment is just a phrase used to sell an incompetent product for a high price.
Why you should not invest in insuranceThe purpose of insurance is to give financial protection to your family in case of your absence. As a general rule, an adequate Life insurance plan should give you 10 times of your annual income as life cover. In a traditional plan and ULIP, the life cover you get is near to exactly 10 times the premium(for 10 years tenure). Which means – to get 10 times of your annual income as life cover, you’ll have to pay all of your income as premium.

The life cover should be enough to take care of all the expenses of your family like regular expenses, children’s future education, marriage, etc. thus the 10 times of your annual income as life coverage itself will not be sufficient enough.

But when you invest in traditional plans and ULIPs, your life cover will be very low to take care of all these expenses. If you want such a good life cover through an insurance investment plan, then you will have to pay a really heavy premium or choose a pure insurance plan like Term plan.

The purpose of investment is to earn high returns. When you invest in insurance, the return you get is extremely low when compared with the returns of a pure investment option like Equity or Mutual Funds.

The returns you get from a traditional plan (4-5%) or ULIP (6-8%) is comparatively very low from the returns that a Mutual fund (12-15%) can give you.

Comparing the life cover & return of a Traditional plan with that of a Term plan on your own will show you the difference distinctly. Which is what we have done for your below.

a) Traditional Plan (endowment) Vs. ULIP Vs. Term Plan

[As Insurance]
To begin with, we will see what my techie friend is losing when investing in insurance. We will see the cost of buying that endowment plan and the returns he gets. And then we will see what he will get on insuring in a term plan and investing in equity mutual funds.

Endowment planULIPTerm Plan
Life Cover(sum assured)50 Lakh50 Lakh50 Lakh
Maturity period20 years20 years20 years
Annual Premium2,48,0002,50,0005,000
Net premium payable = 2,48,000 × 20

= 49,60,000

= 2,50,000 × 20

= 50,00,000

= 5,000 × 20

= 1,00,000

So, on this simple comparison, we see that my techie buddy is about to pay ₹ 48 Lakh to get a life cover of ₹ 50 Lakh from a traditional plan.

A ULIP could take ₹ 50 Lakh in total for 20 years and will receive a life cover of about ₹ 50 Lakh or a little more depending upon the NAV of his investments.

Whereas, if my friend chooses a Term Plan, he is supposed to pay only ₹ 1 Lakh in total for 20 years and his family would receive a life cover of ₹ 50 Lakh upon his untimely demise.

Can you imagine the difference between the life cover of nearly – 0 times & 50 times? You get the same death benefit in the insurance investment plan as you get from a term plan but for 50 times higher price. Don’t get too shocked! I’ve got more!

What compels to get a traditional plan now? The only justification someone could give to choose a traditional plan is that it gives an assured sum at maturity.

Fine, now you know the difference between the premium of term plan and an insurance investment plan (2,25,000 – 5,000 = 2,20,000). You will have the specific difference amount every year if you choose a pure term insurance plan for your life cover instead of an insurance investment plan like a traditional plan or ULIP. Now if you invest the difference amount in a pure investment like Mutual Fund or Equity, the returns will definitely inspire you to invest more.

b) Traditional plan Vs. ULIP Vs. (Term plan + Mutual Fund Investment)

[as Investment]
As we know enough about the traditional plan and term plan, we will now compare the efficiency of investing in a traditional plan and in Mutual funds in detail.

In this stage of comparison, we will take the “LIC New Endowment Plan” for the insurance investment plan side; and the “LIC Amulya Term Plan” and “Mutual fund scheme” for the pure insurance and pure investment side.

Traditional Plan returns on surviving tenure

LIC New Endowment Plan

Annual premium = 2,38,090 (without tax)
Policy term = 20 Years

Sum assured = 50 Lakh
Additional Bonus = 40 Lakh (approx maximum value)
(on maturity)
Total return on survival = 90 Lakh

When you buy this LIC New Endowment Plan, you are supposed to pay ₹ 2,38,090 as annual premium for 20 years and at the end of tenure you will receive ₹ 50 Lakh, no matter you are alive or deceased i.e., you pay (238090*20 =) 47,61,800 and will receive ₹ 50 Lakh plus an additional bonus of approximately ₹ 40 Lakh.

For 20 years in total, you will be investing ₹ 48 Lakh to get a maximum return of 6% return which is ₹ 90 Lakh.

ULIP returns on surviving maturity

ICICI Prudential Signature scheme

Annual premium = 2,40,000 (without tax)
Policy term = 20 Years

Sum assured = 50 Lakh
NAV at 8% = 1 Crore
(on maturity)
Total return on survival = Sum assured or NAV whichever is highest.
= 50 Lakh to 1 Crore (approx maximum value)

On choosing to invest in a ULIP plan, you will be paying a sum of around ₹ 48 Lakh for 20 years in total. If you survive the tenure then you will not receive the assured sum of ₹ 50 Lakh, instead, you will receive only the sum assured or the proceeds of NAV whichever is higher.

On choosing an insurance investment plan like endowment or ULIP, you will spend around ₹ 48 Lakh in 20 years and get an approximate maximum amount of ₹ 80 Lakh to ₹ 1 Crore which is 5-8% return.

Term plan + Mutual Funds

We will take the LIC Amulya Term plan for comparison that covers you ₹ 50 Lakh in case of your untimely demise. If you buy term insurance at the same annual premium, it would give you a cover of over ₹ 2 Crores.

LIC Amulya Term Insurance Plan

Annual premium = 5,080 (without tax)
Policy term = 20 Years

Sum assured = 50 Lakh

So as per our advice, if you avoid the insurance investment plan (endowment/ULIP) and select a pure term insurance plan, you will pay a lesser premium and will save an annual surplus amount every year which is,

Annual surplus = Annual premium of Insurance Investment plans – Annual premium of
Term plan

    = 2,40,000 – 5,080
    = 2,34,920

You will be saving around ₹ 2,30,000 every year. At the end of the tenure (20 years), you would have saved ₹ 46,00,000.

Mutual Fund SIP scheme

SIP (Yearly) = 2,30,000
Investment tenure = 20 Years

Return (13%) = 2,50,00,000
(2.5 Crore)

Now, if you have invested this ₹ 46 Lakh in a “Mutual fund SIP scheme” it would have earned you a minimum return of about 12-15%, which is around ₹ 2.5 Crore.

There are also some best mutual funds schemes which have given around 20% return (6 Crore) in the long term like 20 years. This is the difference in return if you make a pure investment with the same money you spend on an insurance investment (traditional) plan. Is that a good enough shock!?

Insurance investment plans like traditional policy(Endowment policy and money-back policy) and ULIP are often promoted with one solid statement that they give you an assured sum on maturity which you will not get in a term plan. But the cost of the premium is too high than pure insurance which gives huge life cover. Also, the assured return on maturity is too low than pure investment. We show here the solid proof to your eyes below.

c) The show-off – Final Comparison

All these insurance policies are just betting games on your life. We have only two possibilities here – you survive the tenure or you die during the tenure.

We have only three options here –

    1) Traditional plan (endowment/moneyback)
    2) ULIP
    3) Term plan + Mutual fund investment

On calculating the returns, we made this tabulation to show you the simple sketch of what you could get on choosing between these options.

Amount you receiveOn choosing
Traditional (Endowment) plan
– investing IN insurance
ULIP
– investing IN insurance
Term plan + Mutual fund
– insuring AND investing
If you SURVIVE₹ 90 Lakh₹ 1 Crore(0+ 2.5 Crore)
₹ 2.5 Crore
If you DIE₹ 50 Lakh₹ 50 Lakh(50 Lakh + as per invested amount)
₹ 50 Lakh + MF returns

I think now you know who the winner is.

5. Key Take-Away

Along with these comparisons and proofs, here are few inferences, specific answers that I gave to my techie friend’s questions, and some personal advice.

a) Advantages of choosing a Term plan as Insurance:

i. You get a huge life cover for a low premium. Riders like critical illness riders, hospital cash riders are also available in Term plans.

ii. Even with a low annual premium of ₹ 5000; on your untimely demise, your family’s total expenses could be taken care with your life cover (₹ 50 Lakh) of including regular expense, children’s future education and marriage, or purchase of a property.

b) Advantages of choosing a Mutual Fund over a traditional plan as Investment:

i. Transparency – the investments in mutual funds are very transparent and also you will be given a daily update on the NAV. In a traditional plan, your money is invested in an undisclosed investment which means you lose transparency.
mutual fund over the traditional plan as investmentii. The returns – from a mutual fund (12-15%) investment has the capacity to beat the inflation rate, but a traditional plan (4-6%) usually fails to beat the inflation rate. Thus the basic purpose of investment is not fulfilled.

iii. Flexibility – a mutual fund gives you the freedom to change between funds and move to different plans at near to no cost. But in case of a traditional plan, you would have already paid a lot of management charges and it becomes hard to change between plans which will attract even more additional charges.

iv. Regulatory authority – mutual funds & stock market are regulated by SEBI and insurance policies are regulated by IRDA. When you invest in mutual funds your investments and transactions are monitored by SEBI with ensured safety. But the investments in traditional plans are not even disclosed and we have no idea who is regulating it.

v. Affordability – of a mutual fund is very high since you can choose to invest in a sip beginning with ₹ 500 per month. But the minimum premium you pay in a traditional plan is way far high than a mutual fund.

c) Advantages of choosing a Mutual Fund over a ULIP as an investment:

i. Returns – Needless to say, the returns from mutual fund investment (12-15%) is far higher than the returns from a ULIP (6-8%).

ii. Fixed Lock-in – ULIPs have a fixed lock-in period and if you intend to close and come out of the policy, you will be incurred with heavy loss from cancellation charges, premium allocation charges, mortality charge, fund management charge, policy administration charge, and the withdrawal charge. In case of mutual funds, the cancellation charges are very low (1%) and there is no cancellation charge if you come out after a year.

iii. Goal basis – Usually a ULIP, has nothing to do with your goals. Moreover, they just keep your money for some participated for some time and give it back to you. In case of mutual funds, you can list your financial goals into short term (2-5 yrs) and long term (5+ yrs) goals and then invest in the funds according to your needs.

iv. Efficiency of Fund Managers – Both Mutual fund and ULIP has fund managers to take care of the investments. The fund managers in mutual funds tend to be more competitive and talented and also exert more pressure to give the best performance. This is because investors can stop investing and move to another mutual fund easily in case of a poor performing mutual fund. Thus it will spoil the reputation of the mutual fund company and thus the fund managers in a mutual fund company tend to be more efficient workers.

The fund managers in ULIPs are mostly not going to face any pressure, because the funds are usually locked-in for some years.

v. Regulatory authority – mutual funds & stock market are regulated by SEBI and insurance policies are regulated by IRDA. When you make a pure investment, SEBI monitors all the transactions with ensured safety. When you invest in insurance, IRDA can only regulate your insurance policy, but your investments in ULIP cannot be regulated by SEBI. IRDA is also not obviously going to monitor the investments because it is not authorized to do so. Thus investing in insurance attracts more risk to capital.

vi. Affordability – a mutual fund scheme is very flexible under many stances, it has SIP investment option, low investment amount (₹ 500 per month), bare minimum closure charge and exit load, the risk involved is minimum, and a hand full of options to choose from and you have control over your investments. Whereas a ULIP is a heavy investment, incurs lots of management charges, exit from a plan will cost you a huge sum of money, and lack of liquidity.

Conclusion

Most of the insurance agents promote a traditional plan as a means of INSURANCE and INVESTMENT. But from an optimist view, it is supposed to be INSURANCE and SAVINGS. If you choose to insure through a term plan and invest the surplus in a PPF account (if you need a safe investment), then also the profits you get will be higher than the returns given by a traditional plan. This doesn’t mean that MF is not a safe investment, Mutula fund is also one of the safe investments in the long run.

The PPF itself gives lesser returns than Mutual Fund, but it is higher than the lowest returns given by a Traditional Plan. From the best of my knowledge and experience, as a Financial Advisor my advice is that the best insurance option for anyone is a Term Plan and the best investment option for anyone who wants to invest is a Mutual Fund.

Please don’t fall prey for fancy words like a hybrid plan, investment in insurance, combo offers and such goofy word tricks of an insurance agent. Understand the basic idea – it is always a bad idea to buy a hybrid, be it your vegetable or insurance or investment or whatever it may be going with a pure stand-alone option would be the best.

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