Insurance is not Investment. Don’t Mix the Two!

Is life insurance a good investment?

If you want a one-word answer, then its NO.

Life insurance is not an investment. Period.

Comparing insurance and investments and trying to pick either of two (or combining them) – is one of the biggest reasons why most people are unable to:

1. Save enough
2. Invest properly (and become rich)
3. Have an adequate insurance coverage

I assume that most of you know that you need to keep insurance and investments separate – i.e. its always about Insurance Vs Investment 🙂

But if you have your doubts, then read on.

Any well thought out financial plan should include the following:

• Insurance
• Savings
• Investments

And one should not try to mix the three.

But unfortunately, the lines that differentiate between insurance, savings and investments are often blurred.

In India, insurance plans that double up as investments are extremely popular. So apart from the life cover that is available during the policy tenure, there are endowment policies that return a lump sum at maturity. Then there are Money-back policies that offer regular payouts at fixed policy intervals and one final payout at maturity. And there are hundreds of variants of these two popular insurance products.

But people buying an endowment plan or a moneyback policy don’t understand that they are not getting the best of both worlds by buying a hybrid product (that combines insurance with investments).

Instead, they are getting a product that is neither a good investment nor a good insurance.

Ofcourse, it is convenient to have just one product that takes care of everything.

But convenience should not result in sacrifice of the very reason why the product is being purchased – returns (for investment) and cover (for insurance).

Isn’t it?

So to put it bluntly, life insurance as an investment tool – is a flawed concept.

Why do people think that insurance and investment are same?

This is the biggest problem.

And the root cause of this problem is the status of tax-saving instrument – which is given to insurance plans.

Ask people about their investments and they will tell you that they invest in insurance!

Common tax treatment is the main reason why people compare insurance with investments and end up buying insurance-based investment products. This is also the reason why people think that once they are done with their tax planning, their financial planning is over too (which is wrong again)

Then there has never been a shortage of our family friend(ly) insurance agents, who have always been over-optimistic about the reason one should purchase insurance – to earn returns 🙂 and not as protection for dependents.

They will tell you everything about what an insurance policy can do for you – like death benefits, maturity benefits, bonuses, accident riders, etc. But they will never tell you about what would happen, had you simply purchased a term plan and invested rest of the money elsewhere.

(If you don’t understand what I am trying to hint here, don’t worry. I will come to the comparison in a bit. Then it will become crystal clear.)

Don’t mix Investment & Insurance. Why?

Let us take them one by one

When you invest, your main aim is to earn high returns. But when you mix investment with insurance, i.e. you ‘invest’ in insurance products 🙂 like endowment or moneyback plans, your returns are limited – around 4-6%.

Good equity funds can easily give you 12% kind of returns in the long run. So there is an opportunity cost of not investing in high-return products.

When you buy insurance, your main aim to have a life cover that is big enough to take care of everything (family’s regular expenses for years, major life goals like children’s education & marriage, etc.). But when you mix insurance with investment (like in endowment or moneyback plans), your life cover will be low unless you are ready to pay a hefty premium.

In contrast, pure life insurance policies (term plans) give big covers for very nominal premium.

A small personal example…

When I started earning, I was ‘forced’ to purchase an endowment plan as investment.

And if my memory serves me correctly, it was giving me a cover of Rs 5 lac for an annual premium of around Rs 30,000.

I later dumped that policy. I now have a term plan (one of many), which gives Rs 50 lac cover for about Rs 5000.

To summarize,

Earlier: Rs 5 lac cover – premium Rs 30,000 (traditional insurance policy)

Now: Rs 50 lac cover – premium Rs 5000 (pure insurance policy)

See the difference?

Infact, the ‘family friend’ who forced me to purchase the traditional plan was trying to convince me to create a life insurance based investment strategy! Thank God I realized what it meant – after just few years! 🙂

Many people ignore pure insurance plans because it gives no returns if they survive (on maturity).

But we must not forget that life insurance is not there to make us rich when we are alive. It’s to ensure that our dependents don’t become poor when we are not there.

Lets now see exactly why buying a pure insurance product is better than buying a traditional insurance product…

Traditional Life Insurance Policy Vs. Term Plans 

For the purpose of illustration, I am taking a popular endowment (+ whole life insurance) plan by LIC named New Jeevan Anand. For more details about why this policy is not suitable, please read Should you Surrender LIC New Jeevan Anand plan?

Suppose that a person aged 30 years, wishes to purchase an insurance policy with sum Assured of Rs 25 lac for a period of 20 years.

He has the option of either going in for a traditional insurance policy (like endowment plan) or a simple term plan.

The premiums for both policies will ofcourse be different. Lets see ‘how’ big the difference is:

Premium (Endowment Plan) – Rs 1,44,858/-

Premium (Term Plan*) – Rs 3996/-

(Premium data source – LIC’s own premium calculator)

* LIC eTerm Plan

Surprising. Isn’t it?

The difference in premiums is huge!

Agreed that term plans don’t give back anything in case you survive the policy term. But don’t you think that every year, the term plan leaves you with an additional amount (surplus that you save by not buying endowment plan) that can be invested elsewhere for better returns?

You might argue that endowment plans too offer returns if held till maturity. But returns given by traditional insurance plans are abysmally low – around 4-6%.

Simply speaking, for Rs 1.4 lac that you pay annually as premium, the insurance cover you are getting (Rs 25 lac) is shit inadequate! A simple term can give you same coverage for just Rs 4000.

Whether Rs 25 lac cover is enough for you or not is another question (check this article on how much cover to buy).

But what I am trying to highlight here is the huge difference in premiums.

Infact a cover that is four times larger (than Rs 25 lac cover), i.e. Rs 1 crore can be purchased using term plan at just about Rs 16,000. And this is the premium of term plan offered by LIC (plan name – eTerm). The private life insurers will offer the same cover at even lesser premiums!

Now lets put nail in the coffin of traditional insurance plans 😉

_____

Endowment plan (Rs 25 lac cover) – Rs 1.44 lac annual premium

Term plan (Rs 1 crore cover) – Rs 16,000 annual premium

Annual premium difference – Rs 1.28 lac

Also note that term plan is giving a 4-times larger cover than endowment plan.

Lets see what happens at maturity…

Endowment Plan (at maturity)

Insurance Cover – Rs 25 lacs

Total Premium Paid – Rs 29 lacs (20 years x Rs 1.44 lacs)

Maturity Amount – Rs 50-60 lacs or maybe 70 lacs.

Let us compare this with a combination of Term Plan + Equity Funds (giving 12% annual returns)

Term Plan (at maturity)

Insurance Cover – Rs 1 crore (four times that of endowment plan)

Total Premium Paid – Rs 3.2 lac (20 years x Rs 16,000)

Maturity Amount (from term plan) – Rs 0

Maturity Amount (from equity funds – investing Rs 1.28 lacs annually) – Rs 90+ lacs

So the clear winner in case of maturity amount here is a combination of term plan + equity funds. The amount you get is more than what you would have got had you bought an endowment plan.

Also, you get a life cover that is 4 times larger than that given by the endowment plan. That too at 1/9^th the premium.

What else is there to think of now?

Read the above example again (to really understand it)

Now lets come to the case of policyholder dying during the policy term.

Depending on when exactly the death happens, the amount paid to nominee will be equal to sum assured (1.25 times of SA in case of New Jeevan Anand) + accrued bonuses. This would be anywhere between Rs 31 and 60 lacs.

Compare this with term plan – death during policy term will lead to term plan paying out Rs 1 crore to the nominee. In addition, the amount that is already invested in equity funds (in previous years) will also be available for the nominee.

Again, a combination of term plan + equity funds seems to be a better choice than endowment plan.

What if we don’t invest in Equity Funds and instead choose low-risk PPF?

The benefits of term plan + PPF combination will be lower (than Term+Equity Funds) but still better than endowment plans. This is because historically, returns given by PPF are lower than those given by equity funds.

So depending on your risk profile and asset allocation requirements, you can club a term plan with either PPF or equity funds or even both!

As for tax benefits, all instruments discussed – endowment, term plan, PPF, ELSS mutual funds offer tax deductions. So not much to compare here.

But do note that the money invested in equity funds is available to you as and when you want (after 3 years in case of ELSS). But bonus accrued in endowment plans are paid only at the time of maturity (though you can take a loan against it).

What Should You Do?

• If you have recently bought the policy (less than 3 years old), then stop paying the premiums and forget about the policy. Bear the losses. Switch to Term Plan + Equity MF / PPF mode. It will work out better in the long term.
• If your traditional policy has completed 3 or more years, make them paid up or surrender them (read How to Surrender LIC Policy Before Maturity?). Take the surrender money and invest it elsewhere. Buy a large term plan.
• If your policy is close to maturity, then there is not much you can do. Better stick with it. And if you think that your current insurance cover (death benefits + bonus) is not adequate, then purchase additional term plans to enhance your life cover.

There will always be people who will not get convinced about the superiority of term insurance plans over traditional plans. Such people will eventually end up getting mediocre returns and inadequate life covers.

Then there are many people who do realize the mistake in having bought traditional insurance policies. But by the time they realize it, it’s already too late.

But if you are smart enough 🙂 and do understand that insurance is not an investment and its best to keep the two separate, you will know why term plans are the best option for your insurance needs.

They are cheaper, give bigger life cover, the amount invested elsewhere earns better returns and can be withdrawn in times of need (unlike the accrued bonuses of traditional endowment plans which is only available at maturity).

So is term insurance the best form of life insurance?

I think it is.

Though insurance is no alternative to investments, it must be kept separate from investments (and savings) and that is what a term insurance helps you do.

Don’t try to take sides on investment vs insurance debate. Both life insurance, as well as investments, are necessary. Just make sure you keep them separate.