Saturday, January 24, 2009

TYPES OF INSURANCE POLICIES AS INVESTMENT TOOL


Okay , now let me tell you that I am here not going to tell you the textbook definition of what insurance is and what the dirrents types of classification of the same based on textbook stuff. You will get that in any random book on the subject. They will tell you tthe various types of insurance policies but they dont tell you which one actually neans what and should you invest it in them , and if yes then what should be your time horizon for the same? They mostly give you textbook knowledge which at the end of the day may not necessarily help you make a better informed decision .


Hence I am going to help you understand the broad types of the insurance polices based on their constitution and the purpose they servce.


There are broadly only 2 types of life insurance polices ( there are non life insurance policies as well.. more on that later). They are


1. Pure Term Insurance Plan


2. Endowment Plan




Now where does this leave the more popular ones like Money Back , ULIPs etc. Let me explain to you this. Lets first understand what exactly is a Pure Term Insuarnce Plan.




1. TERM PLAN AS INVESTMENT TOOL


A term plan is an investment option basically serving the need to offer financial protection to the policyholder against any unforseen circumstances/eventuality that may arise in future for the defined period of time ( called tenure) and for the defined limit of liability ( called sum assured) i.e. if something unfortunate were to happen to the policyholder during the tenor of the policy then the dependents fo the policyholder get the sum assured to take care of ll their financial needs. So it essentially serves to ring fence them from vagaries of life, financially. But if nothing were to happen to the policyholder then he wont get anything. Then why would anyone buy this plan if it does not pay anything on survival. the anser is that because it serves you protection only and no return or maturity benefit the premium ( money paid against this service) is ridiculously low as conpared to the normal endowment plans.




In India most of the life insurance companies have such plan, but they dont advertise this much coz since the premium is lesser here they dont make too much money by offering this service.




However I suggest you can try LIC's term plan, Even the Kotak Life Insurance term plan is quite competitive.




2. ENDOWMENT PLANS AS INVESTMENT TOOL




Endowment plans are those plans which will both life cover and also survival benefit or maturity benefits. Then isnt this better option , you might argue. The answer to that is an emphatic NO.Will explain it to you why. The reason is very simple, on first look it may sound tempting to invest in endowment because you will get both cover which will help you in case of any untoward incident happening to the policyholder and also the survival benefit if nothing happens. But you must understand that nothing comes free. What endowment plans dont tell you is that they neither give you enough life cover for the same money paid for term policy nor do they give decent returns. On top of that they charge huge charges unlike term plan where the charges are minimal. For instance any random endowment plan in the market will take away anywhere between 50%- 80% of your firdst year premium as charges. This continues for few more years though every year the charges keep coming down . Nonethe less they are still robbing you. So if you pay Rs 100 as premium they eat away 50 to Rs 80 as charges.. isnt it a daylight robbery. And they do this coz they ahve to pay huge commission to the agent who sells you this policy. So beware of those sweet talking agents. They cant see beyond their immediate commission paycheck.




Now these endowment policies are packaged and sold in various forms with minor changes here and there. They all have one underlying principle and that is they take huge premium offer relativley lesser life cover and also offer some survival benefit which may be paiad at maturity or at regular inetrvals like Money back from LIC etc.




ULIPS too are a form of endowment plan only. The only difference is that unlike traditional endowment plans they invest in equity markets /debt markets etc. Traditional plans mostly invest G Secs and Corporate bonds. So chances of you making money are higher in ULIps.






Lets do a comparative study between Term Plan and ENDOWMENT Plan




TERM PLAN
High Life cover at low premium.
No surival benefits.(some plans have that as well but then they charge extra premimum so avoidable.)
LOW premium
LOW upfront charges
Recommended for everyone
Offer Sec 80C benefit





ENDOWMENT PLAN
Low life cover at relatively high premium.
Survival benefits are there
HIGH premium
HIGH upfront charges
Not recommended. Rather go for term plan and FD/Mutual fund.
Offer Sec 80C benefit








Lets also do a comparative analysis between ULIP and traditional Endowment plan




TRADITIONAL ENDOWMENT PLAN


- Invests in G Secs and Bonds.


- Risk free intrument.


- Low returns.


- Survival benefits are fixed.






ULIPS


_ Invest in equity market.


- Relatively risky intrument since its exposed to the equity markets.


- Higher returns.


- Survival benefit is not fixed and is based on the market value of the investments.






So, in the end what should YOU buy?? If I were in you rposition I will definately buy myself a pure term insurance because its a very very useful product which will help me save myself andf my dependents from any financial uncertainlty that may arise in future at relatively lower rates.




And as far as returns are concerned I would invest in Mutual funds , sicne it does offerhigher returns over a long period.




So . TERM PLAN - A MUST for everyone.


Stay away from ENDOWMENT.

Thursday, January 22, 2009

Why should you NOT Invest in ULIPS??

One of the most common mistake that people do these days is to fail to distinguish between need for investment and need for security. More often than not people tend to fail to understand the huge implication it has on their decisions regarding money. This is true for people from all walks of life. I amazed at seeing the lack of awareness about various investment opportunities among educated and savvy people . Hence I am going to point out few of the cardinal mistakes that people do especially while deciding on buying insurance.
What is the purpose of buying insurance? By definition an insurance product is meant to protect the policyholder from any uncertain eventualities that may occur in his life and thus it aims at ring fencing the policyholder and his dependents from any financial crisis that the eventuality might bring with itself. But how many of us actually buy it only for the safety sake?
Lets see the popular reasons why people buy insurance (ULIPS mostly) in India.
1. The most popular reason why insurance sells is that it is thought to be tax saving instrument.
2. Because it is supposed to give you both protection against any uncertainty and also returns at maturity. So its like shooting 2 birds with one arrow.
3. Because the insurance agent hard sells this product.
4. It is supposed to be ideal mix of insurance and mutual fund.
Now lets examine the myths associated with each of the above mentioned points.

1. The most popular reason why insurance sells is that it is thought to be tax saving instrument. While it is true that ULIPs help you save tax under sec 80C what is worthwhile to remember is that this is just one of the many instruments available under Sec 80c which offers you the same benefit. There is no benefit which is exclusive to this product. And when you consider all other demerits of this product then you will know that saving tax by investing in ULIPS would be nothing less than shooting yourself in the foot.

2.Because it is supposed to give you both protection against any uncertainty and also returns at maturity. So its like shooting 2 birds with one arrow. This is only partly true . It does offer you protection and return but none in full measure. This means that by investing in ULIPS you neither get the benefit of higher insurance at low premiums which you will get under pure term plan nor you get the return that you will get by putting money in well diversified mutual fund. so this is a case of neither here nor there.

3. Because the insurance agent hard sells this product.This is the last reason why anyone should be buying any financial product leave alone ULIPs. Financial advisors are supposed to be experts at giving financial advice but most of them sadly are good at giving advice which will help them and not their clients. So in effect they will sell you a product in the guise of advice which will help them make good commission. So they sell ULIPS coz it gives them very handsome payouts as compared to a pure term plan or Mutual fund.
For ex- An agent gets upto 30% of the first year premium that you pay under ULIP as commission, while if the same agent where to suggest you a combo of term plan and mutual fund then at best he will make about 1-2% of the total money invested as commission. No wonder why we dont find too many advisor talking about term plan and mutual fund combo.

4. It is supposed to be ideal mix of insurance and mutual fund. There are few who try and give a intelligent spin to their sales pitch by claiming that ULIP is an ideal mix of mutual fund and insurance. Or worse they will tell you that in ULIP while you make money by being invested in the market you get the insurance free. Nothing can be farther from truth than this. First understand that nothing comes free. In ULIP too when you get insurance cover there is charge called mortality charge which is deducted from the money you invest. Plus there is commission that the company pays to the agent + the admin charges+marketing expenses etc all this can be as high as 50-60% of your first year premium if not more. this means if you invest 100 rs in ULIPS only 4-=50 rs will be invested and rest is eaten away by the company /agent etc. Compare this with a term plan and mutual fund the overall charge is not more than 2-3% of the total money invested which means about 97% of your money is accounted for and is invested for you .
So in the conclusion what should you do to save tax , get protection ?
Answer is to understand the difference in the need for security or insurance and investment. For insurance buy term plan which is the cheapest form of insurance. For investment choose any well diversified mutual fund.
Hope this helps you save your money from the smart and cunning advisors out there to con you into the ULIP trap. Check this video out to get an idea about the miss-selling prevalent in India regarding ULIPs.There are many kinds of miss-selling , this is just one of them. More on this in other post.


video