Is Insurance an Investment?

Over a 10-15 years time, a working adult typically purchases a variety of policies from his insurance agent. However buying too many insurance policies at different points in one’s life for a short term objective ( saving for 80c) without having a long term goal would only leave you with a mixed portfolio of policies with different premium paying terms, different maturity amounts, maturing at different times. Also most people do not realize that even after putting together all their policies they are under-covered with respect to their life – this is simply because they were not sold the right policies in the first place.

The classic conflict..
The objective of insurance is to provide compensation for loss and no more than that. Whereas the objective of investment is to provide the best returns commensurate with risks undertaken. Despite their conflicting foundation, investors would not choose to keep insurance & investment separate, why? This is because of the structure of the instruments and investor’s behavior response to these instruments.

Market-linked insurance premiums are designed to be very rigid, in the sense you sign the contract saying you’d pay a fixed premium for a fixed tenure and if you choose to drop out early, you accept to lose all or part of your premiums. On the other hand, mutual fund SIPs are designed to be more flexible both in terms of the amount and term – there is also no contract that says you lose all or part of your contributions should you decide to drop off anytime. Yet, investors choose the former over the latter.

Investor behavior!
Investors are usually driven by market sentiments and may hop on and off of mutual fund SIPs (Systematic Investment Plan) depending on market swings. However when they buy a market-linked insurance plan, they are most likely to stick diligently with their premium paying term due to fear of loss of premiums already paid. In a way, investors prefer the rigid “fathering” behavior of insurers and trust insurers to provide superior returns from the same market in which they could have independently invested via flexible Mutual fund SIPs. Surprisingly investor behavior shuns the freedom and flexibility of mutual fund SIPs while chooses the rigid insurance premiums.

Now the story on “returns”
When buying a market linked policy, a portion of the policy holder’s premium goes into buying risk cover (say 25%) and only the rest (75%) goes to buying units of a fund. So, you are already starting with a reduced capital compared to a mutual fund SIP. The life cover portion that the 25% buys would anyway not be adequate to cover your life. Next, even if the units earn the same returns, your insurer would deduct additional fund management costs and provide you only with lower returns than your mutual fund house.

On a cumulative basis, your absolute returns from the market linked insurance policy at the end of the 20 year term could well be 80% lower than your mutual fund SIP over the same term. There are other measurable and comparable attributes that your financial planner could throw light and provide you with the much needed insight. You could then make an informed decision  before buying your next instrument – be it a market linked insurance policy or subscribing to a mutual fund SIP!