Why you should not mix insurance and investments?

Getting adequate insurance, at least life insurance and health insurance, are important first steps towards your financial planning journey. In an earlier post, I had discussed different aspects of term life insurance. I this I’ll share few thoughts on why you shouldn’t’ mix insurance and investments – a very common mistakes which many people make.

Life insurance bundled with investment is often misconstrued as “life insurance”. This is far from truth. Life insurance is just a part of that “insurance” sold as “investment”. These may come in various forms, most common being endowment plans, ULIP and money back policies.

Here are 3 reasons why you shouldn’t mix insurance and investments.

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Why you should not mix insurance and investments?

(This mostly assumes Indian context, but can be applicable elsewhere too)

1  Insurance cover is very little

How much insurance cover do you really need?

You can arrive as this number broadly based upon money needed to achieve family’s financial goals if you are not around. This in turn will be dependent upon your current financial condition (including debts & investments) and your (current and planned) expenses. (You can read this in more details here)

To reiterate – the objective of getting insurance cover is to manage risk. In this case, risk to your life and helping your family sustain in such event. 

Now try comparing coverage provided by endowment plan (or any other insurance + investment kind of plan) versus a term plan for a similar premium. Notice the difference. (Policybazaar/ Coverfox or any insurance website can provide these details) 

For most of the working professionals in India, the recommended insurance cover would be anywhere in the range of  Rs. 50 Lac to Rs. 5 Crore!

Now compare that with a paltry Rs. 5 Lac or 10 Lac insurance an endowment plan or ULIP typically provides.

The question you need to ask yourself is – Will this amount be enough?

 

2. You can get better returns elsewhere

Most of the insurance + investment products either “sell” a return (and agents may promise it, without providing any documented surety).

Do a small exercise when you come across an insurance product  having insurance + investment products:

  • Identify the premium you’ll need to pay for equivalent insurance cover.
  • Deduct that amount from yearly premium you are paying
  • Calculate how much you’ll get if you invest that amount (you can benchmark it vis a vis current FD rates, PPF rates or aggressive mutual fund rate. )

For example,

If an agent asks you to pay Rs. 100,000 per year for an investment, which offers a insurance of like Rs. 5 Lac or Rs. 10 Lac, try this –

  • See how much a term plan for the above sum insured (Rs. 5/ 10 Lac) cost. It is inadequate, but still. Most of the insurers won’t even entertain this small amount. But it is unlikely to be beyond 5% of Rs.1 Lac (i.e. Rs. 5000). A Rs. 50 lac insurance cover for a 30 year old non-smoker will, for instance, cost around just Rs. 5000-7000 per year.
  • For remaining amount. Suppose you invest Rs. 90,000 per year in PPF it will give 8% returns with current interest rate. Bank Equity mutual funds, based upon past data can give at least around 10-12 percent (but with some risk)
  • If there is an “assured” returns promised, evaluate it vis a vis PPF (or any other debt instrument of your choice – say bank FD, liquid fund etc.). If returns are market linked, then there is no surety how much will your returns be. You may be better off investing in a mutual fund directly. (Which anyway the insurance provider will do after deducting a fee)

3. Agents push it usually to get hefty commission

Try mentioning “term insurance” in front of an insurance agent. There is a good likelihood that he/ she will pitch some other “awesome” product or avoid giving you much importance! You may sell be able to buy a term plan, but there is likely to be a good deal of reluctance.

Why?

Because – COMMISSIONS!

Term plan have very less commission for agents. Endowment plans,  money back plans and ULIP offer better commission.

Not difficult to guess which will be promoted. No?

Add to that tax saving which they offer, and our propensity to rush to invest just for saving taxes! The mix of insurance and investments topped up with tax savings can be a good sales pitch.

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As a rule of thumb, simpler an investment product is, easier it is to understand and benefit from that. Complex insurance products may benefit others in the ecosystem more but not the customer.

To sum up, avoid mixing insurance and investments – You may end up doing injustice to both these objectives.

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