Understanding Long-term Investment and Insurance Plans
Quite a difficult task, actually.
 
My neighbour’s son, age 30, has asked me to help him choose a ‘good’ insurance plan. He is particularly interested in an investment-linked insurance plan with ‘double benefit’ – insurance cover, plus safe investment, which would generate a nice lump-sum at the end of the term. 
 
I set out to check such plans.
 
I looked at several such plans from different insurance companies, starting with the grand-dad – Life Insurance Corp of India (LIC). All of them said something like this: Pay RsR per month for 30 years, to get insurance cover of 120xR, plus X amount from your investments if they yield 4% return or Y amount at 8% return.
 
Obviously, such schemes are designed by bolting together two parts – a basic life insurance scheme and an investment scheme. 
 
Unfortunately, the glossy plan brochures did not give me the answers to three questions:
 
- How much does the life insurance cost?
 
- How much fee is being deducted from the return on the investments?
- How much will the investments earn? (Admittedly, this is uncertain, especially over 30 years.)
 
All the brochures I read were filled with lots of information, but no specific answers to these questions. 
 
It reminded me of a line from a popular song (film ‘Aradhana’): “sab kuch kahungi, lekin woh na kahungi”.
 
Regulations in European Union (EU) stipulate that prospective buyers of ‘packaged retail investment and insurance-based products’ (PRIIPs) must be given a key information document (KID), which describes the main factors determining the return on investment, what the costs are, and the level of risk one takes. 
 
Unfortunately, these regulations do not seem to apply in India.
 
I had to find another route to the answers. That could only come from a little bit of number crunching. 
 
I looked at the options available to a 30-year-old male, non-smoker, who is considering a 30-year plan. 
 
For such a person, one reputed insurance company offers this scheme:
 
Pay Rs2,500 per month (pm) for 30 years, and get Rs3 lakh life cover, plus Rs14.2 lakh at 4% return, or Rs28 lakh at 8% return, after 30 years.
 
Excel shows that after 30 years Rs2,500 pm amounts to Rs17.35 lakh at 4% and Rs37.26 lakh at 8%. 
 
Hello? Quite a bit more than the plan numbers, right?
 
A bit of manipulation on Excel shows that over 30 years, Rs2,500 pm produces Rs14.2 lakh at 2.85% (not 4%) and Rs28 lakh at 6.55% (not 8%).
So where does the 1.15% - 1.45% go? Fees, probably. But how much exactly?
 
In one policy document, I did come across these numbers, called the ‘premium allocation charge’.
 
Year 1: 7.5%, Year 2 to 5: 5%, Year 6 onwards: 3%.
 
I leave it to you to figure out, or find out, what this ‘charge’ is.  
 
To return to the 30-year plan. Yes, I have ignored the premium on the life cover of Rs3 lakh. But it is such a small amount that it makes hardly any difference.
 
Let us look at a more substantial life cover for our young man, say Rs50 lakh. A pure life cover from the same company for Rs50 lakh over 30 years costs Rs583 pm.
 
Suppose you deduct Rs583 from Rs2,500 – you get Rs1,917. 
 
Invest this amount every month in any investment, and after 30 years you will get…
 
- Rs14.20 lakh at 4.36% return, and
- Rs28 lakh at 7.9% return
 
Consider the safest option for investing Rs1,917 every month – deposits in State Bank of India (SBI), the bank least likely to fail, in my opinion.
 
If you deposit Rs1,917 pm in a recurring deposit (RD) account at 5.5% (current rate) for 10 years, you will get Rs3,05,776. 
 
Open another identical RD at the end of 10 years, and yet another at the end of 20 years. 
 
When each RD matures, place the maturity proceeds in a fixed deposit (FD) for five years at 5.4% and keep rolling it over every five years. 
 
At the end, after 30 years, you will get the grand sum of about Rs17.23 lakh. 
 
You see? On your own, you can structure a very safe investment plan, which will produce a higher maturity value than the ‘indicated minimum’ 4% return stated in the insurance plan, along
with a much bigger life insurance policy.
 
Of course, rates will change over 30 years, but you can be sure that the return from any investment-cum-insurance plan will be in line with the market interest rates and, hence, this comparison will largely hold.
 
Alternatively, you can invest your monthly payments in a SIP (systematic investment plan) which puts the money into a mutual fund(s) (MF) of your choice, based on the level of risk you want to take. 
 
The great benefit of a SIP in equity MFs is that, over a long period of time, 30 years in this case, the market value builds up. 
 
When the market falls, your monthly payment actually buys MF units at a lower price. When the market picks up again, you get bigger gains. 
 
Historically, equities have always produced good returns over long periods, regardless of the ups and downs in the market, because the stock market keeps rising over time. 
 
Just look at Sensex – January 1990: 1,000 and January 2020: 40,000, an annualised growth rate of over 13%.
 
Yes, a young man should have insurance as well as investments. But he should not try to find both in one product.
 
A bit about – how much insurance? 
 
The norm seems to be 10 times the annual salary. This sounds like a lot, but one must bear in mind that inflation steadily diminishes the value of money. 
 
For example, Rs50 lakh today is worth only Rs18.84 lakh (in today’s buying power terms) 20 years from now if inflation is 5% per annum (pa). 
 
However, if a young man buys Rs50 lakh insurance at age 30, and also invests regularly, his insurance payout will be equivalent to only Rs18.84 lakh if he dies at the age of 50, but his investments would have built up and, together, they will provide a reasonably large amount for his family’s sustenance.
 
So here is my suggested formula for my neighbour’s son:
 
- Work out how much you can save every month. I suggest at least 10% of gross annual income.
 
- Use a part of these monthly savings to pay the premium for a sizeable term life policy, at least Rs50 lakh, preferably Rs1 crore.
 
- Put the rest into SIPs for mutual funds, say 75-80% into equity MFs and the balance into debt MFs.
 
I hope he accepts these ‘words of wisdom’. 
 
Do you agree with my advice?
 
(Deserting engineering after a year in a factory, Amitabha Banerjee did an MBA in the US and returned to India. Choosing work-to-live over live-to-work, he joined banking and worked for various banks in India and the Middle East. Post retirement, he returned to his hometown Kolkata and is now spending his golden years travelling the world (until Covid, that is), playing bridge, befriending Netflix & Prime Video and writing in his wife’s travel blog.)
Comments
sanjit.sca
2 months ago
Nice, genuinely correct advice ????????. Would assist many younger people to take the right call and separate their Life Insurance needs from Investment Plans - This should help get far better returns on investments
sanjit.sca
Replied to sanjit.sca comment 2 months ago
Question marks - typo. Pls ignore them
naresh.bhatt
2 months ago
Excellent explainations. This is exactly what I advise to my clients, in addition I force them to have a PPF account and sip in good quality equity shares rather than mutual funds. Regards Naresh Kumar Bhatt
sanjit.sca
Replied to naresh.bhatt comment 2 months ago
Grt????????????
sanjit.sca
Replied to sanjit.sca comment 2 months ago
Excellent advice
arorasid2711
2 months ago
Well I agree fully with you, only thing I suggest people to buy Insurance 20 times of annual salary, maths is simple at 5% SBI return at 20X, you get X amount annually, so the family gets pretty much same (with inflation eating though) income in next few years, now this 5% can be increased with smart investment and financial literacy, but if you have small kids or planning to have kids, better go for as much insurance as you can and buy it cheap at lower age... and 20X makes more sense to me...
Amitabha Banerjee
Replied to arorasid2711 comment 2 months ago
Dear Mr Arora, Yes, I support 20X life cover, or maybe even more, because it is relatively cheap and a good way of protecting one's family in case of death. I would suggest adding accident cover and critical illness cover, too.
vaibhavaggarwal1494
2 months ago
I do not agree with this. The 4% and 8% shown in illustrations are as per IRDA's mandate. It nowhere means that these are the returns which will be there for the customer. Most good products in insurance, return much higher than the 8% figure indicated. Therefore, this evaluation needs to be done for specific products.

Also, many of these products, including ULIPs allow for deductions under Section 80C as well as provide entirely tax-free returns under Section 10(10D), which is a cost the article has not factored in.

Therefore, I feel this presents an incomplete picture.
Amitabha Banerjee
Replied to vaibhavaggarwal1494 comment 2 months ago
Dear Mr Aggarwal, yes, the 4% & 8% are indicative. BUT, when the brochure says 4/8% return the actual return, as shown in the brochure, is less than 4/8%,, probably due to fees being deducted. The brochure does NOT say how much the fees are. Transparency is lacking, and this is not good.
vaibhavaggarwal1494
Replied to Amitabha Banerjee comment 2 months ago
I agree with that, however, the returns are mostly more than what is indicated in that in the good products
Kamal Garg
Replied to vaibhavaggarwal1494 comment 2 months ago
I perfectly agree here as that 4% and 8% is only for illustration as per IDRA's mandate, which is also misleading, confusing; but that's another matter.
I do not know which product give you more than 8% IRR, please share such details.
vaibhavaggarwal1494
Replied to Kamal Garg comment 2 months ago
Good ULIPs do
chiru.terli
2 months ago
????
chiru.terli
Replied to chiru.terli comment 2 months ago
Perfect suggestion
ar.ravijoshi
2 months ago
Of Course! That is really a good advise for youngsters. They get carried away by sweet talk of the insurance sellers!
Amitabha Banerjee
2 months ago
Thank you Messrs Garg, Godbole, ckar,vsv for endorsing my observations. I do hope other readers will get the clear message "Don't mix insurance and investment".
Kamal Garg
2 months ago
Insurance companies in India give a return of between 5% to 6% p.a.
In fact, in many cases, the insured value is even less than the total premium paid during the tenure.
So the golden rule is "Never mix insurance and investment".
No guarantee, only "projected calculation" and getting hypnotized/mesmerized. And that too happens with so called educated excel savvy professionals even.
pgodbole
2 months ago
Excellent article, written in layman's language. Here is another example being actually peddled by Bajaj Allianz Life Insurance, albeit not about life insurance but as pension product, called 'Guaranteed Pension Goal Plan'.

A 50 year old is required to pay annual 'premium' of Rs. 5,13,347 for 10 years to get lifetime annuity of Rs. 4.00 lakh per year, with payment to nominee of repurchase price Rs. 51.33 lakh (total 'premium' paid over 10 years) upon death of Annuitant. There is no life cover during age 50 to 60 years, this being a deferred annuity product.

A simple calculation shows that future value (FV) of 10 annual deposits accumulated @5.7% p.a. comes to Rs.70.52 lakh. On this FV, return @ 5.7% p.a. comes to Rs.4.02 lakh, similar to what Bajaj Allianz promises.

If this arrangement is made with a bank (existing interest rates are around 6% p.a.), upon death of depositor, nominee will get back FV i.e. Rs.70.82 lakh.

But with Bajaj Allianz, nominee will get back only Rs.51.33 lakh i.e. total 'premium' paid. What happens to difference i.e. Rs. 19.49 lakh?

Did you say fees? But the returns on bank deposits are also net of 'fees'. So what is insurer offering different from a bank? In fact, sooner the annuitant dies, better for insurer as it can then book profit of Rs.19.49 lakh. Is this a cushion for unpredictable change in rate of interest? But historically, it is unlikely to be so low to justify such large cushion. Oh, perhaps I forgot one expense. Hefty commission to Agent!

Yet, there will be people who will buy this annuity product.

Returns will be much higher if money is invested as SIP in a diversified mutual fund.
ckar.vsv
2 months ago
It is true and well explained. It is a simple rule is not to mix insurance and investment. But human mind gets carried away by big numbers after 30 or 40 years projected by the salesman and don't understand NPV of those values. Big , Assured ( Not guaranteed) numbers makes prospects a gullible one. Reason " Getting mesmerized " with numbers
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