The main function of insurance is to provide financial protection from risk and the ultimate risk in the case of life insurance is death. The job of a life insurance policy, therefore, is to protect your dependents in the event of your passing. At this point, the insurer will pay the death benefit from your policy-an amount that should provide adequate financial coverage to your family, thereby compensating for the reduction in household income caused by your death.
There is no confusion thus far. You buy a policy, pay the premiums every year, and when you die, your family receives the death payout. The confusion arises when you combine insurance with investment.
Insurance versus investment
The death benefit mentioned above refers to the insurance aspect of the policy. However, insurance buyers are increasingly attracted to life insurance plans with an investment feature.
Example: 30-year-old Rajeev is shopping for life insurance. His financial advisor suggests a 20-year pure term plan because it is a cheap, no-frills plan, and Rajeev can always switch to permanent life insurance once his budget permits. If Rajeev dies during the duration of the policy, his family will receive a death payout of Rs. 10 lakh. But Rajeev has a question: "What do I receive if I survive the 20-year period?" The finance person answers, "Nothing."
This is not to Rajeev's liking. He feels that since he is "investing" close to Rs. 2,000 per annum for over 20 years, he should have something to show for it if he survives the term.
This is a typical reaction, but life insurance was never meant to give you a good deal. There are alternatives, of course. Instead of a term plan, you could get permanent life insurance-it has no end date and a guaranteed death payout; so your family, at least, will have something to show for all the premium payments you made over the years.
If you still want to add an investment component to your policy, think again. Insurance policies are expensive investment propositions. Taking Rajeev's case again, a 20-year term plan of Rs. 10 lakh coverage costs less than a couple of hundred rupees each month; work in an investment aspect and the monthly premium could rocket to Rs. 60,000-an additional Rs. 58,000.
The question here is whether the return on investment is worth it. A mutual fund could provide returns of 12 percent and more. Risk-averse investors who would rather not dabble in the equity market could benefit from a PPF, which provides tax-free returns of 8.6 percent. Even a fixed deposit at your local bank could give you healthy returns of over 8 percent. Do the math. Does your insurance-cum-investment policy match up to the returns guaranteed by these other pure investment instruments?
Ask yourself why you invest. The answer is simple: to make your savings multiply. Naturally, you want to invest in instruments that promise the highest returns on investment. Compare the figures and you will come to one conclusion: insurance offers extremely low returns; hence, it is a poor investment option.
Written By: Deepak Yohannan
The author is the CEO of MyInsuranceClub.com, an online insurance price & features comparison portal
For more articles by Deepak Yohannan, please visit MyInsuranceClub.com
You may contact him directly on Twitter: @dyohannan