Insurers often bundle insurance and investment together into a single policy. Does it make sense to buy investment-oriented policies from an insurer when their core competence is to underwrite risk? Let’s explore this thought.
Too low an insurance is a bad deal
When you buy a Unit-Linked Insurance Plan (ULIP), you get a compulsory life cover (the sum assured, that is) of 7-10 times that of the premium paid. On paying a premium of Rs 1.5 lakh, a life cover of about Rs 15 lakh comes along.
It is, in most cases, too low a value to cover the financial risk for a family.
You might still need to take additional cover by buying a separate term cover. However, it entails shelling out money unnecessarily for those who are adequately insured, as these life covers come at a cost.
Short track record of insurance cum investment options
When buying a mutual fund scheme, you get to know its risk-adjusted return rating. Many rating agencies and other entities tell if the fund under question is a good performer.
In insurance, you can hardly find such performance trackers. Moreover, the fund portfolios are so diverse that fruitful comparison becomes a stretch.
Investors in market-linked policies can switch portfolios – from equity to debt or vice versa – many times in a year without tax implications. However, what if it is consistently underperforming or failing to beat its benchmarks.
While an open-ended mutual fund investor gets the option to exit at NAV, it’s not the case for investment-oriented insurance policies.
While ULIP has a compulsory lock-in of five years, participative policies penalise investors for premature withdrawal in the form of low surrender value.
There are no taxes on making claims either for life or medical cover. Also, no limits on the claim amount are applicable.
However, if you buy a single premium, participative policy or pension plan, income becomes taxable at the marginal rate.
For instance, in a pension plan, at the time of vesting, while the lump sum amount (maximum up to 33.33%) is not taxable, the rest of the corpus received as an annuity is taxable at the marginal rate. This effectively reduces the post-tax returns for investors.
What’s the opportunity cost of buying insurance cum investment policy?
Let’s compare two options:
Option 1 – buying a participating endowment plan
Supposing a 40-year old individual pays Rs 12 lakh every year for a limited period of 10 years. In the process, he gets Rs 1 crore life cover for 20 years. In addition, the insurer pays a reversionary bonus which is guaranteed at a minimum of 3% of the sum assured.
Assuming they pay 3% every year, the bonus works out to Rs 60 lakh after 20 years. So in all, the investor will get a corpus of Rs 1.6 crore (sum assured – Rs 1 cr plus bonus – Rs 60 lakh) at the end of 20 years.
It works out to a CAGR of 5.2 % on your investments. However, most participative policies give returns in the range of 4-6% over the long term, which is lesser than the inflation rates.
Option 2 – Buy a term policy and invest the rest in mutual funds
Alternatively, investors could pay (conservatively) Rs 31,000 every year (for ten years) to get a life cover of Rs 1 crore for 20 years. He could invest the rest (Rs 11.69 lakh) into equity funds. His portfolio could grow to Rs 2.2 crore (assuming 11% annualised returns on equities). His corpus now will be 40% more than if he had purchased a participative endowment plan.
What to do?
So, separate your insurance needs from that of investment. Buy a term cover to cover the risk of the untimely loss of a family member and medical insurance to cover escalating medical costs. Add personal accident and disability cover as well.
Invest instead in pure investment solutions like mutual funds to chase your financial goals – for retirement or a child’s education.
Separate risk needs from investments and buy pure insurance to take care of financial contingencies.