Tuesday, 16 August 2016

Life Insurance Plan: Why is it not a good investment option?

In the past, I have highlighted the fact that Life Insurance plans are not the best investment option. However, Many Investors still prefer investing in Traditional Life Insurance Plans primarily due to the endowment/money back (Maturity cum Death Benefit) nature of the plans. It is the guaranteed maturity benefits and low risk involved which makes it popular investment product.
Life Insurance as the name suggests is primarily designed to provide insured’s dependents with a financial protection incase of unfortunate event of former’s death. Traditional Insurance Plans provide death benefits as well as maturity proceeds on successful completion of tenure (subject to one occurring earlier) and hence are also known as Assurance Plans.
In my opinion Pure Insurance policies like Term Plans make much more sense as they offer high coverage at nominal rates which enables Individual to diversify rest of the fund in other financial products with better returns.
Life Insurance Plans do provide financial protection along with lumpsum benefits but as far as investment and return of investment (ROI) is concerned it is not a viable option.

Participating Insurance Plans

Insurance Plan offering guaranteed death/maturity benefits along with Simple Revisionary Bonus (SAB) and Final Additional Bonus (FAB) are known as Traditional Participating Plans. The SAB is determined and declared annually based on the performance of the participating fund.

Non Participating Plans

Insurance Plan does not share surplus earned by the Insurance Company. The benefits are clearly stated in the policy document and no bonus is paid to the insured. Guaranteed Additions and Maturity Benefits are mentioned at the inception of the policy which cannot be altered by the insurer later.

Factors which makes Insurance Plans a Poor Investment Product:

Traditional Life Insurance Plans are expensive: Insurance Plans carry mortality charges, administration and allocation charges which are not easily understood by common people, this charges levied on Insurance Plans escalates the cost resulting in higher premium amount. Insurance Plans carry higher premium rates as they offer guaranteed maturity returns.

Low Life Insurance Coverage: The coverage offered under Traditional Life Insurance Plans is very low with respect to premium paid towards the same. In comparison to Term Plan, one has to pay almost 10 times more premium for similar coverage.

Inflation Rates Higher than Returns: The returns offered by Insurance Plans are much lower than the inflation rates which means in the long run one ends up with negative returns on the Investment. For example:
If Inflation Rises @ 8% annually while Insurance Plan offers return of 5% per annum, it implies that the return is negative. In the longer run the erosion of wealth is substantial.

Poor Return on Investment: Returns offered under Life Insurance Plans is very poor and ranges between 3%-5%. This is a very conservative investment approach and such kind of returns over a long tenure proves ineffective.
Even Fixed Return Investment instruments provide much higher return on Investment (PPF,NSC).

Lack of Diversification: Since the approach of Insurance Plans is conservative the investment is primarily in debt and bonds offering fixed and low returns. Thus Insurance Plans lack diversification which hampers the scope for better returns on Investment.

Power of Compounding Ignored: Most of the Traditional Insurance Plans normally announce Simple Revisionary Bonus (SAB) based on performance of the Plan which is calculated on Sum Assured. This SAB is calculated annually only on the Sum Assured component and thereby loses out on compounding returns.

Uncertainty on Returns: Since many of the policies are Participating Plans, the returns are uncertain so Individuals cannot determine the actual return they may receive on completion of the policy tenure. Too add to it, the returns are pretty meager to say the least.

Better Financial Alternatives Available: Financial Products offering higher returns are available in the market which is aimed at Conservative as well as Aggressive Investors. One can safely invest in Public Provident Fund (PPF) or Balanced Funds as they offer better returns with minimal risk.

Thus, Traditional Life Insurance plans should not be seen as an Investment option, as it provides very poor returns and inadequate life cover. One can always opt for Term Plan which provides better cover at affordable rates while for Investments in Public Provident Fund (PPF) and Mutual Funds should be the ideal option. 

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