Beware of the Life Insurance Trap!
Did you know that most Indians are under-insured? Considering that we collectively purchased close to Rs. 6 Lakh crores (6 trillion) of life insurance premium last year, this might sound a bit strange but its true! The roots of this problem lie in the rampant mis-selling that is present in the insurance industry.
Not all Life Insurance policies are alike. Some are market linked, some provide fixed benefits, and some provide no maturity amount whatsoever.
“Life cover,” the most critical feature of a policy, takes a backseat as agents focus its savings or investment aspect as its key selling point because pure risk plans are small in size and do not fetch them high commissions. And it’s a well-known fact that in our country, Life Insurance is sold, not bought!
After ULIP commissions shrank drastically in 2009, insurance agents shifted their attention to endowments and other traditional plans, although these plans only provide 4-5% returns on average.
Many clients who seek our help with their fruitless life insurance portfolios are completely unaware about how much total life coverage they even have! This is a classic case of “buying the right product for the wrong reason”
It’s not surprising that many clients come to FinEdge with a bagful of insurance policies that are essentially worthless!
If you’re worried that your Life Insurance portfolio isn’t adding value to your financial future, take charge today, Collate all your Life Insurance documents and prepare a simple spreadsheet with the details of your annual premium payments, one-time premium payments made, and the duration and quantum of life cover that each policy provides. Get your numbers in place.
Working with a conflict-free & trusted investment expert can help you tie your insurance plan together with a more holistic goal-based Financial Plan. While the average Indian is indeed underinsured, those who have the support of an investing expert are not only adequately insured - but also well on track to meet their important financial goals. Our experts can help you clean up your life insurance portfolio and make a fresh start!
Your Investing Experts
Five Typical Life Insurance Sales Traps to watch out for
Watch out for these five typical life insurance mis-selling traps.
“Plan ABC will give you a guaranteed return of X%, which is an excellent cushion against the present market volatility”
Wrong because: No Life Insurance plan, even a traditional one, guarantees any return. In fact, ‘returns’ from traditional plans are opaquely represented as an annual bonus, calculated as a percentage of sum assured, which can be very confusing and misleading. This annual bonus is contingent upon the performance of the insurer. ULIP’s, of course, are market linked and their NAV’s fluctuate just as much as any other market linked instrument.
“Plan ABC is better than Mutual Funds because its returns are tax free u/s 10(10D)”
Wrong because: if it’s a traditional plan in question, it’s an apples-to-oranges comparison. Traditional plans are structurally incapable of delivering anything more than 5%-6% annualised returns over long time frames, so their tax efficiency really becomes a moot point. If it’s a ULIP in question, well – there’s probably slightly higher merit to the argument; but their tax efficiency doesn’t necessarily make them superior to Mutual Funds, when you take their charges, poor 5-year liquidity, inbuilt deduction of units as mortality costs, and relative underperformance compared to top mutual funds into account.
“Traditional Plan ABC is best for your child’s education, because it guarantees cash flows at critical points in time”
Wrong because: First, these plans will do not take inflation into account. Education costs are escalating at 7%-10% per annum in India, and what costs Rs. 1 Lakh per year today will cost a whole lot more a few years down the line. Second, if you actually plot these cash flows into a simple excel sheet, you’ll discover that the returns (computed as XIRR) will actually be sub-6%; which, you’ve got to admit, is an abysmal growth rate for a long-term investment. In fact, given a choice between a ULIP and a traditional plan for your child’s education, a top performing ULIP is a whole lot more superior – but your agent will probably not suggest it as it nets him a much lower commission!
“ULIP Plan ABC is excellent because it’s newly launched, and its funds have low NAV’s”
Wrong because: its factually incorrect that a low NAV is ‘cheaper’ and hence better. In fact, the reverse is applicable. A ULIP with a long-term track record of market beating performance may have high NAV’s, but is likely to continue performing better than a newly launched ULIP with ‘lower NAV’s’. Ultimately, NAV’s mean precious little, as future NAV growth in both the new and old ULIP (in percentage terms) will depend solely on how the underlying securities within the funds’ portfolios perform in the future.
“Plan ABC is worth considering because it offers you up to X free switches in a year”
Wrong because: this is a moot point. You really don’t want to be switching around your funds (in a ULIP) so much anyway. In fact, publicizing the ‘free switches’ feature to too much encourages clients to time the market and move in and out of funds in the fruitless endeavour to generate better returns by doing so. This, more often than not, works to their detriment. One switch a year to smartly rebalance one’s portfolio to their target asset allocation is more than enough, thank you!
Three misleading Life Insurance Communications
Did you know that only around half of all Life Insurance policies go on to complete 5 years? This is a very low number and the roots of this problem lie in the way that Life Insurance is sold, and the problem usually begins with the nature of the marketing communications that some insurers employ. Here’s a compilation of the top three most misleading insurance marketing communications that are doing the rounds nowadays…. Be careful!
“Invest 160,000/p.a for 12 years and Get 1 Cr Tax Free Maturity and Life Cover 35 Lacs to 1 Cr from ABC Insurance Company”
Misleading Because: this SMS misleads one to believe that one can ‘invest’ Rs 1.6 Lakhs a year in a life insurance policy for 12 years (just Rs. 19.2 Lakhs out of pocket) and receive a maturity amount of Rs. 1 Cr - tax free. This works out to a monumental internal rate of return of 23.86% per annum! Considering that traditional life insurance policies front end most of their commission pay outs, and invest the bulk of their funds into G-Secs, earning such a return would be impossible. What’s more likely, is that the maturity value of Rs. 1 Crore is payable after around 35 years. This works out to a more believable 6% IRR – and makes the product highly avoidable, to say the very least.
“Get a Pension of 30,000 per month and Get Rs. 60 Lacs for your family by investing Rs. 3,000 per month and save tax”
Misleading because: it leaves out critical details such as the time horizon of the investment, and whether this ‘pension’ will be immediate or deferred. This SMS appears to ostensibly be promoting a unit linked pension plan, which will allow a commutation of Rs. 60 Lacs at the end of the accumulation period. To achieve a pension of Rs. 30,000 per month (or Rs. 3.6 Lakhs per annum), one would need to annuitize around 60-70 Lakhs of accumulated pension, going by current rate being offered by most insurers. Even if you were to earn a CAGR of 12% on your monthly savings of Rs. 3,000 for a 30-year time frame, the final fund value would amount to roughly Rs. 1 Crore. Considering that you’re only allowed to commute 1/3rd of the fund value at maturity (tax free), where’s the 60 Lakh lump sum value coming from? The numbers just don’t add up.
“Get a Rs. 1 Crore term cover for just Rs. 4,265 per annum"
Misleading because: if you scroll to the squiggly fine print at the bottom of the advert, it’ll most likely say “for a 24-year-old, fit, non-smoker male without pre-existing illnesses and with a family history of perfect health”. Most likely, your own premium for a Rs. 1 Crore term coverage will range from Rs. 8,000 per annum to Rs. 15,000 per annum – 2X to 3X the premium being pitched in this communication. If you’re receiving a 1 Crore death benefit for anything lesser, you may want to quickly scan through the claim settlement ratio of the insurer offering the policy. Anything less than 90%, and your ‘cheaper’ policy isn’t really worth it. Think about is what good is it to leave a window of 10% or more open to the possibility of no pay outs being made to your family at a time when the worst possible misfortune has just struck them
FAQ – Life Insurance
Can I invest into Life Insurance in place of Mutual Funds?
Life Insurance is not meant to be an investment, but a pure risk transfer tool. Typically, returns from traditional plans range from 4-5% per annum only. Even Unit Linked Plans do not provide better returns that Mutual Funds on average, due to their high inbuilt costs and below average fund performances.
Why does my agent not recommend pure term insurance to me?
Policies that provide a high life cover require much smaller premium payments, thereby limiting the commission incomes arising from their sale. This creates a conflict of interest that orients agents towards the questionable practice of recommending only high-premium policies, without really paying attention to the client’s actual coverage requirement. Hence, the baffling trend of a nation of insurance-oriented savers being under-insured!
Should I buy a TROP (Term with Return of Premium) instead of Pure Term?
While Term Plans with Returns of Premium do exist, they generally cost nearly twice as much as pure term plans; you’d actually make a lot more money by investing the differential amount in a mutual fund SIP for 20 years!
Should I invest into a Traditional Life Insurance Plan such as an Endowment Plan?
Traditional Plans provide you with a maturity benefit; but the rates of return, although guaranteed, are extremely low. The strategy of combining a pure term plan with a portfolio of top-performing mutual funds stands out as a clear winner.
How much life insurance coverage do I need?
There are two approaches to estimating how much life cover is optimal; the first being the “Human Life Value” or HLV method. Simply put, an individual’s HLV is the amount of money required to replace all future projected income streams arising from that person, were he or she to unfortunately pass away today. The HLV approach contrasts with the “Needs Based” approach, which is more of a reverse-calculation of the quantum of money that would be required to continue financing dependent needs, pay for the fulfilment of their future goals, and pay off their liabilities, were one to meet their unfortunate demise today. Either one of the two approaches may be used. There are also thumb rules that people apply, such as 10 or 20 times gross annual income based on age bands, but these are very crude methods.