Sandeep Shanbhag
Last week, we analysed the Jeevan Aastha policy of Life Insurance Corporation (LIC) and ascertained that the maximum and minimum return from the policy, depending upon the age of the policyholder, would be in the range of 4.69% to 7.32% per annum Subsequently, several readers wrote in requesting an analysis or at least a view on a particular policy of their choice that they had identified. Not surprisingly, all such policies were either unit linked insurance plans (Ulips) or endowment related plans. I decided to address this issue through my column rather than reply to each person individually.I have often pointed out and will do so once more —- I am not in favour of any plan from any insurance company that seeks to combine insurance and investment. Such a blend, without exception, tends to be sub-optimal. It is always better to keep insurance and investments separate. All endowment, whole life policies and Ulips are examples of combination insurance plans.
On the other hand, a term insurance plan is not only the cheapest but the best insurance plan to buy. It has no cash payout at the end of the term. This means, if the policyholder were to pass away during the term of the policy, his family will get the sum assured. However, were he to survive, he will not get a single rupee. In other words, term cover is pure life insurance and has no cash or surrender value.
One might ask why I still favour term insurance as against a traditional endowment or a whole life policy, which at least pays at the end of the day, no matter whether it is the sum assured or the maturity value. I have my reasons.
Basically, insurance is a cost. It is a contract (policy) in which you purchase financial protection or reimbursement against a loss or an unanticipated expense. The price paid to purchase such protection is also called premium in insurance parlance. Such premium is payable, year in year out, till you desire protection from the loss.
Take car insurance. You pay the insurance premium, year in, year out, to protect yourself against the financial damage that an accident can cause. If you are a safe driver and manage not to bang your car during the year, the premium paid is wasted — you don't get anything out of it.
And you are perfectly happy to have done so, so long as you and your car are safe.
Or take medical insurance. Again, premium is paid to defray any costs of medical emergencies or hospitalisation. However, if you remain fit and healthy, the premium paid on buying the medical insurance is lost. But then again, you do not mind this do you?
Why should life insurance be any different? But it is; it always has been.
This is mainly because life insurance premiums come bundled with the pure premium part combined with the part that gets invested on your behalf. The policy is sold more as an investment where the insurance just comes along. However, know that insurance never comes along — it has to be paid for, always.
In the case of life insurance, the premium is known as mortality premium, which is applicable for all polices, year after year, without any exception, till such time the life is insured. Even in the case of single premium plans or policies where the premium is payable only for part of the policy term, nonetheless, the mortality premium keeps getting deducted every year from the fund value. So once again, insurance never comes along; you buy it, year after year.
Let's take an example to understand this concept further. Say you are 30 years old and desire to buy an insurance cover of Rs 10 lakh. Were you to buy an endowment plan, the premium you would pay would be around Rs 39,000 per annum. However, a term plan would cost just Rs 3,800 per annum for the same risk cover of Rs 10 lakh. The difference between Rs 39,000 and the pure risk cover cost of Rs 3,800 is the investment premium. This is how premiums differ for a constant sum assured. Now, let's see how the sum assured changes for a given constant level of premium. For a premium of Rs 23,000 per annum, one can either purchase an endowment plan where the sum assured is Rs 6 lakh or buy a term plan with a sum assured of Rs 60 lakh. Your choice.
Of course, brokers earn a far greater commission if they sell you whole life policies than if they sell you a term cover. And the logical argument given against buying a term cover is, why opt for the same when you don't get anything back in the end? But now, hopefully, you would know better.
Before I end, here's an answer to all who asked me if I had a favourite policy. I do have one. It's called "buy term and invest the difference."
(Figures in the article are rounded off)
The writer is an investment and tax advisor and can be reached at sandeep.shanbhag@gmail.com
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