Life Insurance - Myth & Reality

History of modern forms of life insurance in India goes back almost 200 years when Europeans setup their life insurance companies to insure the lives of westerners living in India. Subsequently lives of Indian natives were also covered. First at heavy premiums & later at equitable premiums as compared to the ones being paid by Europeans in India.

Before we move on to the few common myths about life insurance, it is necessary for us to understand the peculiarities of this form of insurance as compared to the rest. Few important differences (from end user perspective) for life insurance as compared to other forms of insurance are:

1) Loss cannot be indemnified – Once the life is lost, there is no indemnity/ repairs. It’s a point of no return.
2) Claim can be made only once – Unlike general insurance, the claim for life insurance can be made only once. E.g. one can claim car insurance multiple times.
3) Initiator of insurance claim – Unlike in other forms of insurance, the claim for life insurance can never be done by the owner of the insurance policy or the insured. The beneficiary is always someone else!

There are a few major reasons why an average person goes for Life Insurance. These are the reasons which carry some of the myths too.

Firstly for safety or risk cover. This has to be the biggest motive behind taking up an insurance policy. The insurance claim can never be made by the insured. Hence the safety or risk cover is always for the family members who are left behind & not for you. I see many people taking insurance policies for their kids. While this has an emotional value, if I look at such insurance policies from pure risk perspective, I see no reason for doing this. Unless your child is an earning member, taking an insurance policy in his/ her name is not going to help. I would strongly recommend insuring only those individuals whose death will cause stoppage of income or increase expenses or will make the survivors pay for his/ her liabilities.

Secondly as an investment option – Many of us go for endowment, money back or Annuity/ pension policies from the point of view of earning returns. However if one looks at the kind of returns one is expected to receive on investments in insurance premium vis-à-vis let’s say long term bank deposits then the investment motive for life insurance begins to look weak. Let’s take an example of Life Insurance Corp (LIC) in India since it has the longest & solid history. One of their best endowment insurance policies today is Jeevan Saral. In our example the insurer is 36 year old male with standard health. He has 2 options – Option 1 is to go for Jeevan Saral with a sum assured of Rs. 2.5 million. Option 2 – go for pure risk cover (Amulya Jeevan) & invest in bank deposit.

Going with life insurance for pure risk cover & investing rest of the amount in bank deposit every year definitely looks lucrative. Option 1 is financially attractive only when the insurer dies during the tenure of the insurance policy.

One may argue that the maturity payments from LIC are tax free which is not the case with returns on bank deposit. I agree completely. However there are a few options there too – one could go for direct investments in mutual funds. Mutual funds have historically provided higher gains than banks & the long term capital gains from these investments are tax exempt! Again I mentioned “direct investments in mutual funds” & not the ULIP (Unit Linked Insurance Policy). Why? The reason is simple – would you want to pay 24% to 70% charges of your first year contribution? Surprised? This is indeed true. LIC has the lowest “Allocation Charges” @ 24% of your 1st premium while some of the private insurance companies can charge as high as 70%!

As one of the “value for money” consumers, I have one simple rule - Pay vendors for their core competencies. Pay the insurance companies for what they do the best i.e. insurance/ risk cover & pay the mutual funds for their investment management skills.

Another point of view is – Why would LIC restrict total sum assured per individual to Rs. 2.5 million on pure risk cover policies? This restriction does not apply to other types of policies. Obviously there appear to be strong business reasons behind this restriction. They surely want to encourage their customers to go for policies where LIC has the most financial benefits! Take this example – I interviewed one of the best LIC agents in Pune. He has around 10 year career with LIC. Over this period he has provided new policies with total risk cover of Rs. 600 million & total insurance premium payments of around Rs. 15 million. Any guesses as to how much total value of claims were made by his clients in these 10 years? Well, it was not more than Rs. 4 million! And he mentioned that the claims were slightly on higher side when he compares with his fellow agents!

To conclude - As a tool for Income Tax rebates & pure risk cover, life insurance definitely sounds attractive. I think pure risk cover policies offer the biggest value for money. Insure only those individuals whose death will cause decrease in income or increase in expenses or will make the survivors pay for his/ her liabilities. One should treat insurance premium as expenditure rather than an investment. Pay the life insurers for their core competence only – risk cover!