Keep your insurance and investment goals separate :

We do a lot of due-diligence before shopping for an expensive item. We check out various shops to explore options and bargain for a value buy. Unfortunately, we do not take much effort in buying our financial products.

The basic financial literacy in India is very shallow and confined to the knowledge of different products available in the market. The basic notion ingrained in Indian minds is what returns to expect when they buy a financial product. Nothing wrong with that. However, it should not be at the cost of certain basic priorities. Like we pay for our regular household expenses, insurance is one of the basic necessities of life. In fact, the rule of thumb is that after paying your life insurance premium, the surplus money on hand must be invested in mutual funds, equities, etc. Unfortunately, insurance is perceived as an investment. Outlined below are some real-life examples which will reveal the basic misconception in people’s minds about life insurance. I found some funny too:

A. A life insurance policy (endowment) was sold to my       friend (working) when she was 25 years old. She is filthy rich, hails from a business family and does not contribute to run the household. Do you think she required life insurance when she has no dependants?   

B. One of my highly qualified friends bought a Rs.3 lakh insurance cover for his car. Did you know what his total life insurance cover was – Rs.2 lakh. Strangely, his car seemed more valuable than his own life!

C. Another friend bought an expensive ULIP which she did not even need. Why did she buy it, because she could not say no to the agent as she was her close relative!  

D. A Unit Linked Insurance Plan (ULIP) was sold to a senior citizen, who was paying hefty premiums on it. Now, does he require an insurance cover in old age when his children are well settled and looking after him? The agent who sold the ULIP argued that it was an investment product sold to him, not insurance. Imagine an expensive and risky equity product sold to your parents during their retirement years!  

E.While buying an insurance policy, the first question  that my neighbour asked the agent was how much return can he expect from the policy.  

Apparently, the loss of human life and its financial implications for a family seem so irrelevant when one refers to these instances of buying life insurance. Technical details like how much cover is adequate (refer to my article dated 22 June, 2011), number of dependants in family, existing liabilities, etc are hardly discussed. By keeping investment in mind, many people end up buying insurance which is not in conformity with their needs and goals. They pay hefty premiums on such products but still remain under-insured.

When you ask people about their investment portfolio, they invariably end up mentioning money back and endowment policies. In such policies, the family will get the sum assured and the maturity value in the event of loss of life during the policy term. If the insured survives the policy term, he gets the surrender value. However, under these policies popularly pitched by agents, hefty commissions are paid out of your investment. Thus your savings portion accumulates slowly leading to abysmal low returns of 5-6 per cent, not even beating inflation.

On the other hand, a term policy is a pure insurance cover. It is meant to cover only for the risk of life loss and does not pay you any money against the premiums paid. The commissions on term policy are low and are thus not heavily promoted by agents. It is the cheapest form of insurance offering the best combination of coverage and cost.

The difference in the premiums of a term policy and an endowment policy are quite stark. Consider this: If a 30 year old buys an endowment policy of 10 lakh for a 20 year term, the annual premium paid would be Rs.47,950. If he buys a term policy for the same cover and term, he will have to cough out just Rs.3,230. This is just seven per cent of the premium cost of the endowment policy. So if a term insurance is bought and the premium difference is invested in other option like PPF, equities, mutual funds, gold, etc., the returns are bound to be much higher. 

That does not mean endowment policies are not suitable to buy at all. If you can afford to pay heavy premiums, have a conservative risk profile and are content with minimal returns, you can go for endowment/money-back policies. But make sure you are adequately covered. One can also buy a huge term cover plan and balance it with a small endowment cover.

So do your homework and ask your agent the relevant questions. Evaluating the financial risk for the loss of your life is more crucial than focusing on how much return your insurance product earns for you.