Why investing in a life insurance policy is not a good idea

Just an insurance or term insurance plus mutual fund?

If you are asking whether investing in the insurance policies is profitable, you are at the right page. The powerful combination of a life insurance policy and a mutual fund is explained here.

The job of the insurance companies is to cover the risk of the insurance buyers. A policy holder buys the risk coverage at certain charge called premium. This is the simple transaction and calculation if it happens only in this way. But, we never want to lose money, we don't want to spend our earnings for buying policies to cover our risks. We think this expense is a waste of money. There is no argument on the requirement of insurance. The majority of the Indians are not having insurance cover, even if they have it is not adequate. Life insurance companies give investment plans to attract the customers. They lure the customers by saying they will give handsome returns on their investment along with the insurance coverage. This is the most stupid argument that most of the times would be able to convince the prospective buyer. The buyer would be in loss thinking he is making a profit.

The return on the insurance policies is not attractive. This is due to the taxes, various charges including mortality charges, commissions etc deducted on the premium paid. The amount available for investment would be very less. Ultimately, the return on investment will be lesser when compared to any other investment opportunities including bank FDs.

I have prepared a live example to prove my case. Remember, nobody can exactly tell how much return one will get in an insurance policy or a mutual fund. The calculations are based on historical data. I have taken the best returns for the insurance product and a poor or below average returns for my method of combination of a term insurance and a mutual fund. This is just to prove even if you had selected the costlier and lesser returns products in my method you should be the winner.

CASE 1: Only LIC

Let us calculate the returns of a simple endowment plan Table No 0814 of LIC of India. I have considered a sum assured of Rs 25,00,000 with a term of 30 years for a person aged 30 years so that he/she is covered for life risk through out an important period of life and get the maturity benefit at the standard retirement age of 60. The annual premium for this policy is Rs 78571.

Endowment plan premium calculation. Screen shot of LIC of India website

Let us calculate the expected returns. The returns on this policy include the annual bonus + terminal bonus + sum assured. The bonus is given on the total sum assured of your policy. You can view the bonus rates at LIC website. The bonus rate per Rs 1000 sum assured usually ranges from Rs 30 to Rs 50. Even though LIC has not given Rs 50 per Rs 1000 sum assured bonus for this product, I will consider it for the calculation purpose. You can check basunivesh website to know how to calculate the returns on an LIC policy.

Bonus per year at the rate of Rs 50 per Rs 1000 sum assured is Rs 1,25,000

Total bonus for 30 years is Rs 37,50,000

Assuming terminal bonus at Rs 100 per Rs 1000 sum assured is Rs 2,50,000
Total terminal bonus is Rs 2,50,000
Sum assured is Rs 25,00,000
Total of bonus+ terminal bonus + sum assured = Rs 70,00,000

IRR for this investment is 6.00%

You had paid Rs 78571 per annum to get a life risk cover of Rs 25,00,000/- for 30 years and a lump sum of Rs 70,00,000 after 30 years.

CASE 2: LIC with Mutual Fund

Now, instead of hiring an LIC agent for both the risk coverage and investment, let us give the task of risk cover that is insurance to LIC agent and investment task to UTI mutual fund advisor.

Term plan premium calculation. Screen shot of LIC of India website

As per LIC website we need to pay Rs 5,812 every year for 30 years to get an e-term life insurance of Rs 25,00,000 for 30 years. This policy is available only online. As your far relative, LIC agent uncle is behind you for a policy, let us consider a policy available with them. The premium for this policy if we take from an agent becomes Rs 6,878. This is a non-refundable premium and is an expense for you.

We wasted (!?) Rs 6,878 out of the total amount of Rs 78,571 and left with Rs 71,693 for investment. Keep this amount in your savings account, as this is the least unproductive financial plan you can do. If we divide this left out amount by 12 months, it comes to Rs 5,974. I take Rs 6,000 a month to simplify the calculation leaving the saving bank interest added to it for spending on your own discretion.

What to do with the Rs 6,000 a month? Do mutual funds SIP.

UTI is the first to start mutual funds just like LIC in insurance. I consider a tax saver of UTI mutual fund even though it is an underperformer. It also gives income tax benefit like insurance. The returns are also not taxable under the present tax law. The least return it had given is CAGR of 9% in last 10 years. Some of the debt funds have done better than this with low risk. Let us see what happens when you select this just two starred low performer for your investment.

OMG!! You get Rs 1,10,66,844!!

SIP return calculation. Screen shot of SBIMF website

By the combination of a term insurance and a mutual fund, you get a life risk cover of Rs 25,00,000/- for 30 years and a lump sum of Rs 1,10,66,844 after 30 years. You get Rs 40,00,000 more than the first scenario.

What is your call?

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