One of my NRI clients recently mentioned that his father-in-law was talking about the booming insurance market in India and how several people had approached him with some great insurance products that offered handsome returns.
He thought even my client should buy one. The best part was that the father-in-law was 62 years old, but then who cares.
Insurance companies have a bestseller in the form of unit linked insurance plan, ULIP. As far as they are concerned, the only thing that matters in this plan is whether the person can pay a premium for the next three years. Even if a 62-year-old feels he doesn't need insurance, the agents of these companies will try to sell it to her/ him.
But something that sells well isn't necessary great and we all have come across several examples of this. When one opts for an insurance policy or a financial product, what is important is not whether it is a bestseller but whether it is suitable and relevant to one's needs.
Similarly, whether ICICI Prudential, Bajaj Allianz or any other company is number one is immaterial.
Here's another thing to keep in mind -- don't invest in a ULIP just because most of the policies that are sold are ULIPs. The product you invest in should be the one that best suits your needs; and this need not necessarily be the most popular ones.
The primary purpose of insurance is to ensure the well being of your dependents in the event of your untimely demise. So why are we saying that you should give ULIPs a miss?
Here are some reasons:
~ In the initial few years, the costs of servicing your ULIPs are very high. They vary from 15 per cent to 65 per cent depending on the scheme and company chosen by you. What this means is that, if you invest Rs 100,000, only Rs 35,000 (65 per cent cut) to Rs 85,000 (15 per cent cut) will remain for actual investments after deducting charges.
~ The cost of insurance keeps increasing every year as per your age. For example, if you are paying a mortality charge (that part of your premium that goes towards covering your life) of say Rs X when you are 30 years old, this figure can go up to Rs 2X by the time you are 40. And it keeps going up. The worst part is, since these amounts are deducted from the units, you do not see the impact of these charges on your NAV. Which is why a lot of people don't realise this happens.
~ Opaqueness of charges: Difficult to really understand the charges with so many charges under different heads. To understand this better, read 'Why ULIP is not the best insurance product'.
~ In any equity linked insurance product, fund management skills play a very important role. But the best fund managers in the Indian investment industry and in the world are found either working for mutual fund houses and not in insurance companies.
~ When investing in insurance, investors do not have a choice to change funds mid-way if the investments don't do well. In other investment options, investors can sell and move to a different investment.
~ Beware before you buy such bundled products (a mix of insurance and investment) like ULIPs. Ask yourself would it help if you keep your insurance and investment needs separate. While investment needs primarily seek decent returns, insurance needs are meant to protect your family or dependents in case of your death or permanent disability.
~ Remember, your insurance needs go down as your wealth increases. It helps to have a term plan that you can quit at any time without worrying too much about surrender charges and how much will you lose if you exit later. If you stop a ULIP plan in between, you pay a part of your accumulated money as charges for stopping the premiums. This is known as the 'surrender charge'.
These are some of the common concerns that you should look at before putting your money in ULIPs.
Needs-based analysis of your insurance needs
Assess your and your family's needs and make a calculated assessment.
Some important things to keep in mind
- Loans to be paid off
- The kind of lifestyle you want to provide to your family
- Your non-working spouse (if relevant) who wouldn't have an income if you were to die
- Your child's education and marriage expenses
- Providing for your parents, if they are financially dependent on you
Once you determine the above factors, you run the following calculations
1. Lumpsum capital needs on death
a. Clearing home loan
b. Clearing car loan
c. Daughter's / son's education
d. Daughter's / son's marriage
e. Emergency funds in case of your sudden death/ permanent disability
2. Monthly income needs
a. Monthly household expenses
b. Monthly income of you and your spouse
c. Shortfall, if any (calculated as your monthly/ yearly expenses less income)
3. a. Current invested assets (excluding residence, car and other personal assets)
b. Current life insurance coverage
c. Total = a + b
d. Shortfall = (lumpsum capital needs on death) + (monthly income needs) - Total
Once you determine the amount of life insurance you need, just buy the cheapest insurance policy available in the market. Term insurance policies are generally considered the cheapest as they do not promise you any returns. The premiums that you pay go to cover the mortality charges.
Most ULIP agents and companies tell their potential cleints that insurance is a long-term product and the higher costs charged by ULIPs in the initial few years should not be see as a deterrent to investing in ULIPs. The stress is obviously on the word long-term.
But don't forget what John Maynard Keynes, the great economist, had once observed, 'In the long run, we are all dead.'
Amar Pandit is a certified financial planner and runs the Mumbai-based firm My Financial Advisor.
