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Insurance plans & mistakes we make
Govind Pathak | May 14, 2007
The best thing you can buy from an insurance company is an 'insurance policy'. However, the sad truth is, most of us look at insurance products as investments, on which we will get back some money when the policy matures.
As a result, by opting for returns, we land up paying more for a 'pay-back policy' than going for a pure insurance scheme where a higher death benefit would go to our family.
But take a pause and think if things were to go right, we have many other ways to provide for our family. And it could be through our regular income streams like salary and other instruments, where we have invested.
The basic idea of getting insurance is to hedge against your unfortunate demise, which could severely impact your family's ability to maintain the same lifestyles. But since you are looking at insurance as an investment, the amount of cover you can garner can be pathetic.
Let us take an example. If your age is 40 years, and you have Rs 10,000 to spare each year, a term insurance policy will offer you a cover of Rs 17.75 lakh (Rs 1.8 million) but no money if you survive. If you put the same amount in a unit linked insurance plan, since you are looking for returns as well, for the same premium, it will reduce your cover to just Rs 200,000 and the rest will go towards investments (minus charges).
In other words, after taking this Ulip, your insurance cover is actually Rs 200,000 but you stand to gain by the way of bonuses during the 20 year tenure, if you were to survive.
For those looking at investing through insurance, you can also look at products that guarantee exactly what money they will earn in 20 years. These guaranteed products have different names depending on the insurance company selling it. For instance, Birla Sun Life simply calls it Premium Back Term Plan.
Unlike a pure term insurance, where you do not get anything back at maturity, in this case the insurance company will not only give you the cover but also pay all the premiums back to you at maturity.
You can choose to get either all of your premiums back through a 100 per cent premium-back plan or an extra 25 per cent over and above the premiums you have paid through 125 per cent premium back.
As odd as it may sound, you actually stand to lose money by investing in these premium-back polices than by buying pure term insurance where you don't get any money back. Take us take an example, Deepak and Vaibhav are good friends. Both are 40 years old and doing well in their careers. Both decide to take insurance of Rs 50 lakh (Rs 5 million) for a period of 20 years.
Vaibhav opts for a premium-back plan where he gets Rs 50 lakh cover for 20 years at an annual premium of Rs 69,035. To top it, he gets all his premiums back after 20 years. Deepak, on the other hand, opts for pure term plan, where the premium is Rs 25,871 a year. But he would lose his entire premium payout of Rs 517,000 if he were to survive the tenure.
After 20 years, Vaibhav has a cheque Rs 13.64 lakh (Rs 1.4 million) to show. Deepak, meanwhile, has nothing to show. However, his Public Provident Fund account has Rs 21.33 lakh. A good Rs 8 lakh more than what Vaibhav has.
This is because he saved Rs 43,164 (Rs 69,035 minus Rs 25,871) lesser per year than Vaibhav, and simply invested this extra money every year in one of the safest investment options, that is PPF. That money grew at the rate of 8 per cent per annum to Rs 21.33 lakh )Rs 2.1 million).
The fact is while both of them were covered for Rs 50 lakh. But Deepak had to put aside much less for this insurance cover whereas Vaibhav had to put aside more than double that amount. Even if the PPF rates had dropped to 7 per cent or just 5 per cent, immediately after he had started investing, Deepak would still be richer than Vaibhav.
And this is an example that considers only PPF as the investment vehicle. The returns on Rs 43,164 (the excess amount) in an equity index fund instead of PPF would be much higher.
This is because the horizon is long and index funds are well-diversified and therefore less risky. A tax-free 10 per cent return would be possible over 20 years. And the cheque worth Rs 27 lakh (Rs 2.7 million), instead of Rs 21 lakh (Rs 2.1 million). Irrespective of his investment decision (PPF or index fund), Deepak is better off than Vaibhav anytime.
Bottom line: Buy only pure term insurance from an insurance company and invest the rest somewhere else wisely.The writer is director, Acorn Investments Advisory Services