I know this is a very abused topic in the personal finance world but the way it keeps coming up alarmingly everyday made me revisit it. Most of my clients have truck loads of life insurance policies that was sold to them without their knowledge or understanding not to mention that most of these policies could possibly be from LIC. I think one needs to give a serious look to understand why life insurance is not an investment.
The rational behind having such policies is that it givens me x% rate of returns and is a good investment. Well, is it really ?
Do you mix business with pleasure ?
There are some things in life which are meant to be done straight and simple. Seldom do you mix Maggie with curd and eat it – SRK did that in RAOne and you can see the outcome. You don’t get me, do you ?
I assume you have a car or a two wheeler. It is mandated as per law to have insurance for that. If you think for a moment, you will realize that this motor insurance is a policy that is meant to replace damages to your vehicle should there be an accident to should it be stolen. Why is that so ?
The idea is to get you, the owner of the vehicle, back to same economic condition should a loss occur. So if your car meets with an accident, your insurance policy pays to repair the car and you get the car back in the same condition it was earlier.
And that is and should be the main purpose of insurance. It should be meant to protect your losses in life. Losses could cover damage to property, your vehicle, your health, income and even your life. You have insurance for all and it works life a charm for everything expect life. More on that in a bit.
An insurance is a contract between you and the insurance company. Both of you decide that you will pay a small amount of money, called the premium, to the insurance company for them to cover your loss, should it occur. If it does not occur, you lose the money that you pay as premium. If the loss does occur, the insurer sticks to its promise and pays money to you to repair the product in question.
So in your car insurance, if your car is not stolen or damaged, you lose the money you pay each year to the insurance company. And if you have a theft, the insurer pays you money so that you can buy a new car.
Similar is the case for health insurance. If you land up in a hospital, then you spend money on medical test, doctor’s fees, medicines and often there is loss of income as well. Insurance can ensure that they pay you for all of these to get you back to the same monetary condition you were before you landed at the hospital.
So what’s the argument for life insurance ?
Why life insurance is not an investment
The problem lies when we take this discussion to life insurance. As the words indicate, in life insurance, investors are covered for their lives so if they die, the insurer pays a large sum of money, called sum assured, to the family so that the family has money to live their life.
The simple issue is that we end up having insurance policies that will not put our family back in the same monetary state if we were to die. So we make a contract with the life insurance companies wherein, we leave behind money for our family that is sorely going to be inadequate for them to survive.
And that happens because we look at insurance as an investment class. If you expect a life insurance policy to generate some returns for you, then the premium that you pay will be larger and the amount of life insurance cover provided will be less. This is where most of the investors are caught in today. In today’s inflation dominated India, a life insurance policy of Rs 5 to 10 lakhs will be sorely inadequate to provide for anything for your family when you die.
Premiums are money lost
In India, life insurance is sold and has historically never been bought but that is changing now. So when it was sold, life advisors pushed those products which fetched them maximum commissions. This worked well with investors as well because they were told that the money they were putting in would be returned to them in some form or the other. And thus different types of life insurance policies were sold to investors – endowment, money back, whole life and the so infamous unit linked insurance plans (ULIPs).
There is a common thread between all such purchases – investors think they have been smart enough to buy insurance which will protect their life and at the same time return some money to them. The real big issue is that when you do that, you pay a large premium that could better have been used elsewhere in a more productive way. Also, you end up being under-insured which is so sad – imagine for a moment how your family will survive and whether they can meet all their future aspirations when you are not around ! In short, you the smart investor pay more for being under insured !
Understand that life insurance is meant to protect the economic loss that your family will have to go through when you are not around. While the emotional loss cannot be filled in so quickly and only time can heal such wounds, note that it is in your hands today to ensure that enough money is there for your loved ones to live life king size.
The solution obviously is to stick to pure vanilla term insurance policies and be ready to lose the small premium forever should you survive. You can then be smart enough to invest the rest of the money for your long term and short term goals.
Or you could still eat maggie with curd.