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Consider this. Your friend tells you of an investment product, which generates a cash flow of Rs 1 crore for your family if you die of natural causes during the next 20 years, but nothing at all if you survive. To buy this product, you have to invest only Rs 10,000 every year for the next 20 years. And here is the attractive feature of the product: If you die during the period of the investment contract, say, in the 6th year, your family does not have to make the annual investment, but will receive Rs 1 crore! Will you buy this investment product?
Risk
If you are a typical individual, chances are you will consider this investment risky. You will evaluate your chances of surviving in the next 20 years. And if the likelihood of survival is high, you will rightly conclude that the investment is unattractive. After all, why pay Rs 2 lakh (Rs 10,000 times 20) over the 20-year period and receive nothing in return? You would have realised that the product we are discussing is typical term insurance policy. And such contracts are not investments. They are just… plain insurance — contracts that indemnify your family for loss of your income should you die. Of course, discussing about death or dying is not really exciting, but nevertheless necessary. Why?
Loss of income
When you consider your insurance policy as a tool to indemnify a possible loss of income in the future, you may seriously consider term insurance policy — contracts that do not have any survival benefits. But when you consider the premium that you pay as investment, you require something in return, even if you survive. And that compels you to look for an investment feature in an insurance contract. Insurance companies oblige you by offering policies with survival benefits. The issue is that such policies carry high fees and low returns on the investment component (remember unit-linked insurance policies?).
Most of you nevertheless prefer such policies to term insurance because you may be suffering from what behavioural economists call ‘framing’. This refers to behaviour where you react differently depending on whether a product is presented as a loss or a gain. Studies suggest you will typically avoid risk when offered a positive ‘frame’ while seeking risk when you are offered a negative ‘frame’.
The bottom line: Consider life insurance premium as a cost to ‘insure’ your life, not as an ‘investment’ on which you need a return. You might then, perhaps, consider term insurance. After all, term insurance is just like your motor-vehicle insurance. You do not expect returns on your motor-vehicle insurance, do you?
(The author is the founder of Navera Consulting. Feedback may be sent to >knowledge@thehindu.co.in )
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