Life Insurance – some facts

The fact is, term plans are still not sold by insurance agents. That leaves it up to each one of us to seek protection. There are several commonly held misconceptions and myths about life insurance. Unfortunately, some get mistaken for facts. Let’s see which is which. Most people believe life insurance is good savings vehicle.
That is true only if an insured’s idea of good returns is 4% to 7%. Most people expect higher returns, then insurance may not be a right choice. A better option would be the Public Provident Fund (PPF), which gives 8% returns, tax free.
And that rate is fixed (unless, of course, the government decides to change it). If an investor’s priority is safety then he can consider alternatives like RBI bonds, National Savings Certificates (NSC), Kisan Vikas Patra, bank fixed deposits, all of which guarantee returns. Even post-tax (depending on the tax slab you fall into), they will still yield higher returns. Yet, for many people, insurance is the main saving. What makes this choice even more baffling is the myth of safety.
There is nothing safe or guaranteed about returns on an insurance plan—it depends on the performance of the funds invested. The bonus declared varies from year to year, and the post-tax return is less than the other options mentioned above.
That brings us to another reason why people buy life insurance—to save tax. For tax savings, insurance is a very good option but not the only one. There are several other ways to save tax. One could invest in PPF, NSC and ELSS (equity-linked savings scheme) mutual funds too. ELSS mutual funds have shown a mind boggling 44.88% compounded annual growth rate (CAGR) over five-year period.
The best performing fund, the Magnum Taxgain scheme, has fared even better: 63% CAGR over five years. PPF gives a clear 8% returns year on year, compounded.
The rebuttal would be that the insurance corpus goes into debt and that cannot be compared with mutual fund or equity returns. The insurance doyens would probably point to Unit-linked insurance plans for realistic comparison. To be sure, there’s some truth in the claim that unit linked insurance products ULIPs) can give good returns, like mutual funds. But insurance companies eat the premium in the first year and the following few years, leaving a reduced corpus for the actual investment.
The policy holder starts life with a disadvantage. ULIPs can make up in one situation. The mortality charges in a ULIP plan tend to be low. Hence, if you take a high insurance cover (like, say, Rs 50 lakh), the ULIP plan becomes comparable to a combination of mutual funds and term insurance, after about 12 years. This comparison is for some plans with low-charges.
That is, assuming that MFs and ULIPs are going to perform at the same return-levels. There is a concentration risk in ULIPs, as all the money goes to the fund of the insurance company, whereas a mutual fund corpus can be diversified across funds and schemes. Assuming that mutual funds and ULIPs will give the same returns. To date, mutual funds have been winning hands down. As of last week, six large-cap funds have given a five-year CAGR return of more than 50%, while the Sensex has returned 38.15%. The average five-year CAGR for the large-cap category is 44.6%.
ULIP returns are reported on the invested amount, after deducting all the charges, which are substantial. The actual returns are thus far less. The last reason for buying insurance is that it provides protection. At last, the real reason but unfortunately, agents don’t talk about it. No client wants to talk about it, either, since it involves their death (“eventuality”, in insurance lingo). When insurance agents seldom talk about protection and family security, but keep harping on tax breaks, tax free returns, and safety, it’s no wonder that they don’t help customers see the real need for life insurance.
The fact is that term plans are still not sold by insurance agents. The reasons are premiums and commissions are low. Secondly, many medical tests are required, which is a lot of work. And thirdly, policies may be declined, or may be issued at an extra premium. Extra work, lost commissions and that is why agents don’t talk about term insurance. That leaves it up to each potential insured seek protection, which is really the main purpose of insurance.