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How does term life insurance compare with plans that are also investment products?
Life insurance in India is being sought after mostly for investment purposes in India. Unfortunately, the real motivating factor behind taking out a life insurance policy should be to safeguard the interests of one's dependents in the untimely event of death.
Term plans, providing only life insurance, are being steadily disfavored for life insurance products that also act as investment tools. Unlike term plans, life insurance plans with an investment option offer the policyholder a return on the amounts paid to the insurance company. Term plans do not invest premiums. Only in the event of death does the beneficiary receive the sum assured. If the policyholder of a term plan survives the policy there is no value returned and premiums paid are not refunded.
The rationale most insurance customers subscribe to is that putting money in a life insurance policy is like giving money away to someone, without getting anything in return. Nobody really plans the end of their lives and everyone expects to live to old age. The thought that they will lose out, by not receiving anything at the end of the policy term, is not attractive when compared to the rosy pictures painted by hard-selling insurance agents who showcase plans, where one is not only covered for life (just in case something does happen) but also live to benefit as years go by. Also, insurance products are being touted as tax-saving mechanisms and most people don't think twice about taking out a policy just to save on tax for a particular year; multiple policies even.
But what should happen if one has a family to provide for, not just at present but in the future as well? What if one has loans (which a lot of young Indians do these days) viz. a car loan, home loan or even a personal loan? Marriages are still a costly affair and education very important to everyone. How does one ensure that all these financial obligations will be met if the income that funds them is suddenly stopped?
This is what life insurance does. It provides a certain sum that can take care of these costs if the person providing the income suddenly dies. Given the impact inflation can have on future costs, one should try to get coverage for the maximum sum possible. However, to do that one has to pay premiums which is often looked upon as an additional expense by Indians. But what those premiums are buying you is what is most important and a fact that most insured Indians these days tend to neglect.
Term insurance plans are a good bet for the simple reason that they get you the highest possible cover for the lowest possible premiums without the additional frills that most other plans offer. It targets the risk of death only (Riders are available, if one can pay extra, to cover additional situations like disability). It has considerably lower premiums than that paid on other plans. This is mainly because, unlike term plans, insurance plans that promise returns invest a part of the premiums charged in debt and/or stock markets.
Returns on a life insurance policy don't necessarily justify the premiums paid
Most agents try to sell the more complex policies instead of term policies because the premiums are higher on the former type. Insurance agents earn a percentage of the premium as their commission. Lower premiums on a term policy means lower commissions. Also, with the option to buy term life insurance policies online at lower premiums than directly through an agent, commissions are further reduced. Therefore agents do not push term life insurance products. Until the IRDA prevented it, agents could even earn 100% of first premium paid as commission. Insurance education is not widespread in India and most people buy a policy fully trusting agents who appear knowledgeable.
The truth is that the more complicated the policy, the more unnecessary it probably is. Term plans are relatively straight-forward and simple in their offer and features and easy to understand. When an investment option is thrown in, there is very diminished clarity regarding not only what is on offer but also how the premiums are apportioned and invested. Insurance companies and agents do not priorities transparency. Policyholders have to constantly track their returns and switch plans if they are not satisfied. Again, if one is taking insurance for a short-term investment goal it doesn't bode well as life insurance is something one has to stay invested in for a long period of time. Many people do not try to match their investment goals with their investment timeline nor do agents highlight this. Instead, they highlight attractive features like policyholders being able to get money back if the plan is surrendered or earning a bonus if they stay invested for a certain period of time. It may sound reassuring but the policyholder fails to understand that these amounts are given back post deductions as per company terms e.g. losing first premium amount plus other fees.
Avoiding a term life insurance can mean opportunities lost
In many cases, the agent themselves are not well-versed on the offer and terms of the various policies leading to unrealistic expectations by policyholders. The amount invested or the markets/instruments invested in are unclear causing the policyholder to eventually feel unsatisfied with the performance of the insurance company. They end up either switching often or abandoning their plans. This costs policyholders valuable time in starting early with another policy. Even if they decide to eventually switch to a term policy they have sacrificed good years to arrive at this decision. The younger and healthier one is the better the premiums one can avail of on their term life insurance plans.
Insurance companies are not investment managers. They are in the business of insuring risks and in the case of life insurance, their main focus should be on insuring risk of death. Many people wrongly believe that insurance companies provide safe returns. However, without proper management of investments, returns cannot be maximized. To address costs of fund management they charge higher premiums. However, policyholders could divert the same amount to actual fund managers or even directly put it into equity/bond markets for higher returns. If one had to take up a term life insurance plan with a low premium, he/she could then channelize the remainder of their savings into more profitable avenues. It has been seen that even bank deposits can be more favorable than insurance-investment products despite taxation. Many people tie up potential savings by paying higher premiums on complicated insurance-investment products. Apart from unwanted losses and poor returns, policyholders' savings are eroded.
Term life insurance is about financial security not revenue generation
Under a term insurance plan, the policy would lapse if premium payments were missed. This could happen not just due to oversight but due to a shortage of funds. Insurance companies do not offer loans against term insurance plans as they do with other plans. This is to woo buyers who feel the premiums on non-term policies may be unaffordable. The loans offered by insurance companies appear attractive when compared to personal loan rates. However, these rates are only marginally lower than the market rates and the returns from the insurance company are not, in reality, enough to justify the loan expense. It actually ends up creating more financial insecurity for the policyholder. In comparison, term life insurance plans are generally affordable with a given amount of payment discipline.
On the whole, term life insurance plans may have drawbacks and may not be the most attractive in the face of alternative plans with the promise of returns but it is prudent to remember that life insurance is not a revenue generator and the real benefits of protecting against financial insecurity should be a buyer's prime motivator in choosing a policy.
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