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Say you can save Rs 5,000 a month and you want to do the best you can to protect yourself and grow your savings. And, your friendly neighbourhood insurance agent suggests that the best course for you is to put all the money into an endowment plan because it will help you save in a disciplined manner and give a significant sum of up to Rs 12-13 lakh (sum assured or life cover for the product is Rs 10 lakh) 15 years later. The emotional pitch: When your son is going for his higher education, you will have substantial savings to meet his demands. Add to that, there is no risk to your capital and the plan will help you save taxes. Many fall for this and very easily. But should you? The answer is NO. The agent is trying to confuse you by combining insurance and investment, and if you take his advice, you will end up with far lower returns than you can get elsewhere. Let us see why.
If you took a term insurance policy which has no investment component, assuming you are a 35-year-old, for a life cover of Rs 10 lakh, you will need to pay only Rs 250 a month, not Rs 5,000 a month! Of course, in a term insurance policy you get back the sum assured only if you die during the period of the policy. But that shouldn’t bother you, because you are paying only Rs 250 a month now, so you still have Rs 4,750 every month that you can invest elsewhere for far better returns.
At the most basic level, you can invest it in debt, equity, gold or real estate. Physical gold and real estate are not good options for someone who wants to invest a fixed sum of money regularly, so let’s just consider debt and equity. The options here are the public provident fund, fixed deposits with banks, debt funds and equity funds. The simplest of all these options is, of course, the public provident fund. If you put Rs 4,750 a month (Rs 57,000 a year) in a PPF over 15 years, what you should get at the end of 15 years is Rs 17.61 lakh (at the current rate of 8.60 per cent), completely tax-free. In other words, if you follow the advice of the agent, you will lose Rs 4-5 lakh!
For fixed deposits of up to 10 years, State Bank of India (SBI) now offers an interest rate of 8.75 per cent, which means the maturity amount will Rs 13.18 lakh 10 years hence. By way of comparison, the plan the agent is trying to sell you will get you Rs 10 lakh only after 15 years, not 10! In the case of the fixed deposit with the SBI, though, the invested amount will be tax-free, while the interest income will be added to your income and taxed according to your income slab. But even after taking this tax into account, you will be better off with the fixed deposit, no matter what your income slab.
If you invest in long-term debt funds earning eight per cent a year, you will take away Rs 16.03 lakh after 15 years, while in the case of equity funds earning between 12-15 per cent, you'll take home somewhere between Rs 22.39 lakh and Rs 28.93 lakh in the same time. As you can see, in all these cases, the returns are much higher than for the plan recommended by your agent.
As far as liquidity is concerned, you can withdraw up to half the corpus accumulated in PPF starting from the seventh investment year. In the case of equity fund investments also , you can withdraw the corpus after one year with no tax incidence or exit load. The catch here is that if you are using systematic investment plans (SIPs), you will have to wait for all the SIPs to complete one year. Debt funds are exempt from tax after three years of investments.
If the conclusion is so clear, why do so many people still buy complicated insurance products, and why do the agents keep selling them? The second question is easier to answer: the agents get a much higher commission for complicated insurance products than for term plans. Today, a traditional insurance product, whether term or endowment, typically earn agents up to 30 per cent of the first year premium, seven-eight per cent of the second year premium and four-five per cent of the premium during the rest of the policy term. But agents sell investment plans more because the premium amount is far higher in non-term plans than in term plans and, therefore, so is the agent’s commission. (Online term plans fetch agents six per cent only in the first year.)
The are many reasons why consumers go for insurance-cum-investment products. For one, some think it is much easier to deal with a single product that covers their life and also helps them save. What they don’t realise is that a combined product is a more complex one, and the more complex a financial product is, the worse it is for them.
Some others find it difficult to come to terms with a ‘term plan’ because they want something in return for putting in their money even if they don’t die during the term of the policy. Yet, others buy insurance-cum-investment products because they find the tax savings attractive. There are even investors who keep collecting insurance policies – 10 or 15 of them! – as a means of saving taxes. But their reasoning is faulty. As Sandeep Shanbhag, chartered accountant and financial planner once explained, “Buying an insurance product only to save taxes would be like meeting a short-term liability with a long-term obligation. These products are of long-term nature and though you've saved tax this year, you will be paying for it by way of future premiums for many years to come, thus negating the effect of saving taxes.” Rajesh Kothari of Alfaccurate Advisors also thinks using insurance products for investment is not a good idea , “because you will not go to a restaurant specialising in Chinese food when you want to eat South Indian food.” Insurance companies, however, have many ways of making their non-term products look attractive. For example, you may have received messages from insurance agents or companies saying “pay only Rs 3,500 a month and get Rs 1 crore after 15 years”. When Business Standard contacted an agency on receiving one such text message, the monthly premium turned out to be Rs 8,000 instead of Rs 3,500, on account of “agent fee, administration fee, fund manager’s fee and other such costs that the company has to bear on behalf of the policyholder,” as helpfully explained by the agent who happened to be from ICICI Prudential Life Insurance.
That takes us to the fundamental problem that all non-term insurance products suffer from: Lack of transparency. If you pay Rs 5,000 a month for an endowment policy, you do not know what part of it is invested and what part is used for risk coverage – or even what part of it is used for commissions! In fact, even the maturity value is not known to investors in many cases. They only know that they will get the sum assured and some bonus – in case you stay invested for at least seven-eight years.
So the next time an agent tries to convince to take an insurance product that is also an investment, say ‘thank you, but I will just take the term plan.’
Countering sales pitch!
Until a year ago, all insurance agents were busy selling Unit-Linked Insurance Plans (Ulips) as the God’s gift to savers, despite their comparatively low returns. In reality, Ulips were God’s gift to agents, with their commissions being 100% of the first annual premium! Then, Irda came down hard on these insurance-cum-investment plans and capped agents’ commission on these. One would have thought this would make agents go back to selling insurance covers — the basic term plans. But, they are now focused on selling other complex insurance-cum-investment products like money-back and endowment plans.
The commission rate on these products is no different from that on plain-vanilla term plans — typically, up to 30% of the first-year premium, 7-8% of the second-year premium and 4-5% of the premium during the rest of the policy term. However, since the premiums for complex products are many times more than those for term plans, agents make much more commission when they sell insurance-cum-investment products. And, they have a whole range of arguments to convince you why you should buy these products. Here’s how you counter their arguments:
Pitch one: ‘This is a savings product which can be surrendered after three years for a special value.’
Your Question: Why three years? If I put my money in a fixed deposit or other debt instruments, I can exit anytime for a small fee of less than 1%.
What you should know: Surrendering an investment-cum-investment policy will lead to significant losses, which the agent may not be eager to tell you. Surrendering a policy within three years will give you nothing. After three years, you get 30% of the premium paid minus the first-year premium plus partial bonus. ‘Surrender value’ is the term for what a policyholder gets if he terminates a policy or stops paying the premium before the term ends.
Pitch two: You will get assured returns with bonus. Your Question: What will be the rate of return after bonus?
What you should know: “Invest in any debt product that gives you higher returns, apart from the liquidity,” says financial planner, Pankaj Mathpal (see the accompanying story). At present, the rate of return insurance-cum-investment products give is 5.5-6% — much less than even the post-tax returns of many debt instruments. For instance, SBI’s one-year fixed-deposit rate stands at 7.5%. For the person even in the highest income tax bracket, the post-tax return will be 5.25% after taxation of 33% on returns. And, even if you were to just recover the premiums, it is loss because money lying idle in banks would have earned at least 4% interest (savings bank rate).
Pitch three: Traditional insurance-cum-investment products are cheap, and no charges are applicable.
Question: What will be the outgo from the first five years’ premiums
What you should know: Having earned at least 50% of the first year’s premiums as commission in the Ulip regime, insurance agents pitch traditional plans as cheaper. But even 30% of the first year’s premium is high. In comparison, mutual funds charge no fee or commission for investments up to Rs 10,000. Above Rs 10,000, the charge is Rs 100, and that too if the distributor route is opted for. Funds do charge a fund management fee, but that is capped at 2.5%. There are no charges for investing in bank or company fixed deposits.
Pitch four: Returns will be safe, unlike market-linked products.
Your Question: Why should I seek safety of returns in an insurance product?
What you should know: Any investment advisor worth his salt will tell you what you should seek from an insurance company is risk coverage, and not investment returns (see accompanying story).
Pitch five: You can take a loan against this policy to pay the premium
Your Question: Why should I do that? Will the loan be cheaper?
What you should know: The answer is no. The loan against an insurance policy is 1-2% cheaper than a personal loan, but the rate of return on a traditional plan of 5-6% does not justify it — you will still pay a higher interest than you will earn. Banks will give loans only up to 70% of the total premiums paid. All policies don’t qualify for a loan.