Buying insurance? Beware!

Marketing has taken over the insurance industry.

If the aggressive marketing of ULIPs, as an insurance-cum-investment product, was not enough, even endowment plans are being marketed now, as products that give you high bonuses (read returns). A clear indication that savvy marketers are trying to tap the 'returns-oriented' investor by this new sales pitch: 'Get bonuses higher than premiums paid.'

It does sound astonishing. But it is true. The latest pitch from the sales person goes something like this, "Sir, we have launched a new plan where your premium is just Rs X and at the end of the year you will get a bonus of Rs 2.45X." It is really easy to fall for something like this because the numbers look very exciting. And to top it all, it also gives you insurance.

But an annual appreciation of 145 per cent is seldom heard of. You might just begin to wonder whether you have discovered a goldmine. Sounds even better than mutual funds. But then, things cannot be bright and beautiful without a catch. Here is an analysis of the product and how it actually works.

Mr A, aged 30, has an objective to earn higher returns. So he is looking for an appropriate investment avenue. He approached an insurance advisor with this offering of an endowment policy, that gives one an annual appreciation of 145 per cent. Add to this, a protection benefit as well.

The product works something like this. For 30 long years, you pay an annual premium of Rs 32,368. But you also get an annual bonus of Rs 46,000. Hence, the total premium paid in 30 years would be Rs 9, 71,040. And the maturity value would be bonuses plus sum assured, which would amount to Rs 23,80,000.

This money, if divided by the number of years of investment that is, 30 years, the resultant value is the annual income of Rs 79,333. Moreover, if we deduct the annual premium of Rs 32,368, the difference we get is Rs 46,965, which gives an annualised return of 145 per cent.

Sounds absolutely great. But here is the catch.

The bonus that is being paid to you over the period of 30 years is based on a simple rate of interest. That is, Mr A is actually getting 5.59 per cent compounded annually for the next 30 years, which is lower than even the present rate of inflation.

And as all of us know, returns based on simple interest should never be considered as a parameter for investment. An investment avenue should always be selected, with annual return based on the concept of 'compounding.'

So let us find out what is the compounded effect on your yearly investment of Rs 32,368. Had you invested even in bank fixed deposit, you would have garnered at least 6 per cent compounded quarterly interest for the 30-year period. And the corpus would be a princely sum of Rs 1.07 crore (Rs 10.7 million). Of course, there would a tax component application to this returns. But still, the returns would easily beat Rs 23,80,000.

This is an simple example of the power of compounding. Think mutual funds and blue chip stocks and the result would be excellent. As Albert Einstein once said 'The Magic of Compounding is the 8th wonder of the world.'

One needs to realise that insurance is simply a life protection tool. That is, you take insurance so that your near and dear ones are not cramped for cash if something happens to you unfortunately. It should never be looked at as an investment vehicle that gives returns as well.

Therefore, the best way of going about it is going for term insurance. This product gives your life cover but no returns if you outlive the expiry date of policy. This instrument is ideal for insurance purposes.

The main problem is that investors struggle to cope with and understand the new products entering the market. This is because they are marketed rather aggressively. But the moot point is that these are insurance policies and not mutual funds. The basic idea is to separate the two words, insurance and investment and not club them.

It has become all the more important because inflation has been rearing its head again and that means that your real returns from the investments is definitely likely to come down.

In short, one should carefully analyse the different options offered by the companies and then take a final call on their investment strategies. But the bottom line is 'Never mix insurance with investment.'

The writer is Head of Financial Planning at Sykes & Ray Equities and can be reached at kairav@sre.co.in