Don’t rely on insurance for wealth creation

The returns are low and financial commitment high

Whole life insurance policies are becoming popular. They are being sold to individuals who wish to leave a legacy for their children. But unless you are an ultra-conservative investor, there are better options than insurance policies for wealth creation.

The attraction of whole life plan is that the risk cover is for the entire life, and the policyholder gets the sum assured for sure. However, the returns are low and the annual financial commitment is high.

Here we look at why endowments plans, particularly whole life plans, are an unattractive option for wealth creation.

What are whole life plans

In pure protection plans, that is, term life policies, the risk cover is till 70-75 years, as this is assumed to be the maximum age till when an individual will contribute financially to the family. But in whole life insurance plans, the risk cover is for the entire life and the policy maturity is usually at 100 years.

These plans have a premium payment term (10/15/20 years) that is shorter than the policy term.

So, once, at the end of the premium term, and then at the time of death (or maturity of the policy), the policyholder gets the sum assured.

While at the end of the premium payment, the benefit will be sum assured plus bonus, if any, at the time of death (or maturity of the policy), it will be just the policy’s sum assured that will be paid.

HDFC Life’s Sampoorn Samridhi Plus, SBI Life’s Shubh Nivesh, Max Life Whole Life Super and LIC’s New Jeevan Anand are some prominent whole life endowment plans.

For instance, consider an individual aged 40, who has taken a whole life plan for a sum assured of ₹50 lakh and has to pay premium for 20 years.

If he survives the next 20 years, he will get the sum assured of ₹50 lakh and bonuses, if any (if it is a participating plan). Then, if he passes away, say at the age of 80, his nominee will be paid ₹50 lakh again and the policy will terminate.

Getting the sum assured twice makes the product look wonderful, isn’t it?

But if you work out the return (IRR), you will realise that the longer you live, the lower the return; the closer you get to hitting a century, the returns will drop to as low as 4-5 per cent.

Disadvantages

Whole life plans are expensive. If you are young, say in your mid-30s, and looking to buy a whole life plan instead of a pure risk cover, you must be sure about paying the premium till the end of the premium term.

Premium for ₹50 lakh sum assured policy for a 30-year male for a premium payment term of 20 years can be about ₹1.25-1.35 lakh. If you have crossed your 50s, the policy’s premium will be even more expensive.

Suppose at 55 you buy a whole life cover for ₹50 lakh sum assured and the premium payment term is 10 years, you will have to shell out ₹3.5-4 lakh every year.

For 5-6 per cent return, the financial commitment in these polices is too high.

Returns are poor in whole life plans because they are basically endowment products where the funds are invested in government securities and bonds. While this ensures that the risk is lower, the returns are also lower.

What also pulls down the returns in endowment products is that they are traditional policies and the agent commission and other costs are high.

On a gross return of 8 per cent, the IRR of whole life endowment policies works out to 4.5-5.5 per cent because of their high cost structure. The other flaw in traditional policies, including whole life plans, is the very low surrender value.

If you stop paying premium in the first three years, you may not get anything back.

Surrendering at the end of the third year will fetch you 30 per cent of total premium paid.

If you do so between the fourth and the seventh year, you will get 50 per cent of total premium paid. The percentage of surrender value increases with time and becomes 70 per cent after 21 years.

What you can do

There are several financial instruments today that can generate good returns on commitment of a long-term investment.

Based on your risk appetite, you can choose between mutual funds — equity, balanced and debt.

If you are looking for a product that can give higher returns than FDs or pure debts funds, but at the same time, you do not want risk with higher equity exposure, you can even consider equity savings funds — a fairly recently introduced category in MFs.

They invest in equities, debt and arbitrage opportunities (basically equity derivatives).

The funds’ exposure in arbitrage opportunities is about 30-35 per cent, which is to reduce the volatility in returns from equity.

If you are ultra conservative, you can even look at post office schemes — may be PPF.

But if you can stomach some risk, you can consider corporate FDs. Tax-free bonds can be a good option, but at present there are no issues open.

So, if you intend leaving a legacy, invest that amount elsewhere and write a will, making your loved ones legal heirs.

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