Insurance is for protecting your kin, not for saving

Life Insurance. A very vexatious topic. I hear of agents who are part of the “Million Dollar Round Table”. They get paid holidays and vacations at exotic locations. I have nothing against them. They are selling you a package of fear at a price that you will not understand or know.

Life insurance in its purest form is where you pay an annual premium and should you die when your policy is valid, your nominee/s get the insured sum. It is to provide your dependents with financial security. In other words, your death makes a ‘financial’ impact on them. And the important thing to understand is that should you live through the policy period, you do not get anything back. The premiums are not large. And the important thing is that the coverage amount should be substantial enough to provide the dependents with financial security for some period of time.

I see advertisements offering ‘term’ plans at `563 per month for a one crore rupees coverage. The sums vary from company to company. It is important to note that NO agent will generally show you this product.

The insurance agent will try to tell you that you should buy a policy where you get your premium back. It is a big psychological lure. The agent does not tell you a lie, but he hides a lot. These policies go by different names. “Money Back” policies, endowment policies or child plans, etc. Now, in all these policies, if you try to buy something for the above amount of `563 per month, for, say, 25 years, you may at best get a cover of around `2 lakh for your life. The agent will tell you that you get back `2 lakh plus some ‘bonus’ at the end of 25 years.

In effect, you are buying a term plan for `2 lakh. The insurance company uses the money to invest and give your returns after meeting the sales “Term Plan” expenses and the administrative costs. The scale of commissions on a Term Policy typically ranges between five and 2.5 per cent of the annual premiums paid. And since there is nothing to be invested or returned, it does not matter to us what is the level of expenses that the insurance company incurs in ‘administering’ the policy. We simply trust that should there be a death, the full amount is paid without any deduction, to the nominee.

However, when we buy any other plan where there is a financial return to the policy holder during the life of the policy, the way it works is that a small sum is recovered for the ‘life cover’. Then there are ‘administrative’ charges that can range from 1 to 2.5 per cent per annum. Then come the killer charges. There are sales commissions to the agents. The commissions can be as high as 25 per cent of the first year premium and gradually tapering down to five or 2.5 per cent per annum, depending on the structure. Of course. Naturally, the returns will be only on what is invested after meeting all these costs.

Now, if we were to take a ‘pure’ term policy for a crore of rupees, we just spend `563 (an illustrative amount from one policy quote on the net) and treat it as an expense. If we were to get the same cover from an investment type policy, the monthly premium on a 25 year policy could be as high as `30,000 per month. If you were to buy a term policy and invest the balance in a mutual fund, you would get a higher return.

We could analyse any investment linked insurance product and establish that it is financially more sensible to invest in a pure term plan and a mutual fund combination.

Investment and insurance are two separate financial outlays. Do not mix up both.

Some suggestions when you take a Term Plan:

1) Buy a policy only if you need it. If you are wealthy enough that your dependents do not need money should you die, it is pointless. Statistically, most people survive the insurance period;

2) You may start off with buying insurance. At some stage, you will become financially secure and have provided for your dependents. Now you simply stop paying premiums;

3) Check “on-line” rates. They are far lower than going through an agent. You could walk in to an insurance company and some employee will assist you; and

4) Most important factor is to start early in life to lock in to lowest possible annual premiums and to have cover for a reasonably large sum upwards of a crore of rupees.

There are also some unique insurance products that can be useful as an old age help. I will discuss that in another piece.

■ Buy a policy only if you need it. If you are wealthy enough that your dependents do not need money should you die, it is pointless.

(The writer is a veteran investment advisor. He can be contacted at balakrishnanr@gmail.com)