What your agent won’t tell you: Insurance ≠ investment

Typically towards the close of the financial year, throngs of people looking to make tax-saving investments rush headlong into buying insurance products that they know little or nothing about. And since they feel ill-equipped to study the universe of insurance products, they end up blindly acting on the advice of insurance agents, who hard-sell them endowment plans or other investment products on which the premiums — and the agents’ commissions — are higher. But in fact, it is a bad idea to view insurance policies as investment products.

Bundled products have a relatively small risk cover and leave you underinsured. These are sold as endowment plans (which offer returns as a lumpsum at the end of the policy period) or money-back plans (which make payouts at regular intervals). There are two types of money-back plans: participating plans, in which policyholders get a share of profits from the investments of the insurance company; and non-participating plans, where there is no sharing of profits, but returns are guaranteed upfront. Unit-liked insurance plans (ULIPs) also have a ‘savings/investment’ component, but the returns are linked to the market. But whether they are endowment policies (traditional products) or ULIPs, the risk cover they provide in relation to the premium you pay is relatively low.

Your agent may entice you with bundled plans that will “double your money” or help you save taxes, but these are not the reasons to buy those products. Especially if they are traditional plans where the costs are not disclosed and the investment book is not transparent.

So, where does that leave you? If you are looking to buy insurance on value-for-money terms, term plans, which are plain-vanilla insurance products, are your best options.

A term plan is pure-risk cover. At the end of the policy term, if the policyholder survives, there is no return of the premium or any additional returns. In the event of the policyholder’s death during the tenure of the policy, the nominee gets the insurance cover amount.

In term plans, the premium even for a large sum insured (say ₹50 lakh or ₹1 crore) is nominal. For instance, a 30-year male buying a term insurance policy for ₹1 crore sum insured will pay a premium of ₹13,000 a year. For this same premium, the extent of insurance cover he will get from a bundled insurance product will not be even ₹25 lakh.

The risk you run with bundled insurance policies is also that you could you end up under-insured.

Bundled products lure you with their returns. Agents make tall claims that you will double your money in endowment plans, but it’s best not to yield to such sales spiels, which are not even true. In ULIPs, returns are market-linked, but in traditional endowment policies, the returns are only about 4-5 per cent a year. In HDFC Life’s Sanchay, a non-linked non-participating plan, for instance, a 45-year-old male who pays ₹1.5 lakh per annum as premium for 10 years will get maturity proceeds of ₹28 lakh at the end of 20 years, which works out to an internal rate of return (IRR, or annualised returns) of 4 per cent.

Agents mislead customers by showcasing the maturity value of the policy against the premium for comparison. However, since you pay the premium in the initial years of the policy and receive the maturity proceeds over a 5-10 year period or as a lumpsum after 10-20 years, you should also account for the time value of money. The IRR is a more accurate measure of the actual returns in endowment policies as it calculates the net present value of all benefits received at different points in time and then compares it with the initial investment. Calculating the IRR is easy, and even if you cannot calculate it on your own using the IRR function on a spreadsheet, there are online calculators readily available.

In endowment policies, insurance companies do not invest the entire premium you pay: a large portion of that goes towards agents’ commission and some towards administration costs. But there is no way for you to find out what you will charged because insurance companies are not mandated to disclose their costs or agents’ commission on traditional plans. In the ‘benefit illustration’, which comes with the policy brochure, the ‘gross return’ and ‘net return’ on the product gives you an idea about the expense ratio, but you won’t get to see the break-up of costs. Further, these policies also charge a hefty sum in case of policy surrender. Many investors who initially commit themselves to a high annual premium, may realise later that they are unable to keep up with it. But when a policy is surrendered in the initial years, you may not get back all the money in the fund. In traditional policies, costs are front-loaded and the surrender charges are as high as 70 per cent in the initial years. Consequently, you may receive only a small portion of the amount you invested.

In term plans, however, the cost is low: the commission that agents get paid is far less, and the administration charges are also less, given that most term plans are sold online.

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