Investments and insurance should be kept separate

I always tell investors that products should be evaluated on their effectiveness in achieving our important goals. Their multiple features should be examined with this simple perspective.

All our financial goals have two main themes: protection and returns. Term insurance is the only pure protection product while insurance products like endowment, whole life, money back or Ulips are a combination of insurance/ protection and investment/ returns. Essentially, we have to determine whether the convenience of a multi benefit product justifies its additional costs.

For a 40-year old, Rs 1 lakh of pure protection could be bought for Rs 350. If he buys a Ulip with Rs 1 lakh annual premium and a Rs 10-lakh insurance cover, we know that Rs 3,500 is being utilised for protection. Anything less than Rs 96,500 invested to buy units is the cost which insurance companies levy and give it varied nomenclature of administration, allocation, commi- ssion...or marketing. The same benefits can be replicated by buying term insurance separately for Rs 3,500 and units of a good mutual fund, where the entire Rs 96,500 is utilised without any deduction, since entry load is zero.

Old Ulips had very high charges, especially in the first 3 years, ranging between 20-30%. Effectively, only Rs 70,000 was invested out of Rs 1,00,000 in the first 3 years. This has severe negative consequences because of the immense time value of money and compounding, and insurance policies are long term. Rs 10,000 invested every month for 20 years in the growing Indian economy should count for Rs 1 crore. Whether the investor achieves his goals or not, he contributes significantly to the Ulip seller’s comfortable retirement. Even the argument that insurance plans have less fund management charges and therefore, recovery in the long term does not hold water since NAVs reflect these...costs and Ulips, in general, have not demonstrated NAVs higher than comparable mutual funds.

Irda’s recent amendments include increasing the lock-in period to five years from the current three years. Additionally, charges are reduced and evenly distributed, resulting in lower commissions for agents —around 5% in the first year and 2% subsequently, instead of 15-30% earlier. Discontinuance charges are less with an absolute ceiling of Rs 6,000. Besides, minimum insurance cover is higher.

The impact of these changes is good for the investor. They focus on protection and the long-term nature of the product. Earlier, Ulips were being sold as short-term investment products with an insurance veil and taxation benefits. Costs are less and their structure is standardised, making the comparison of products easier. Also, exits are cheaper, though lock-in periods are longer.