Monday, February 3, 2020

Insurance vs Investment

We are into the month of February, the eleventh month of the financial year which spans from April to March. Historically the last three months of the financial year, i.e. Jan to March, have seen an increased demand for Insurance products in India. This is because the premium paid for Insurance products qualify for a tax deduction under section 80C of the Income Tax act up to an annual limit of Rs 150,000. This is quite liberal a limit for most Indians where the average annual per capita income is only Rs 135,048 (ref In a country where the largest insurance company LIC – is owned by the government, Insurance companies and their agents have found it relatively easy to sell Insurance products to the vast Indian middle class on the basis of tax savings that will accrue to them for paying Insurance premiums. This narrative has not only suited the Government coffers very well (LIC paid a dividend of Rs 2,610cr to the Indian Government for 2018-19) but also the mindset of the Indian middle class which has been conditioned over the years into saving its hard earned income in tax saving instruments instead of investing it. Consequently millions of middle class Indians even today are more comfortable buying a LIC policy instead of investing in an investment product such as a Mutual Fund.

Truth be told, this mindset worked well during the post independence era when the Mutual Industry in India either did not exist or was in a nascent stage. However ever since the emergence of private sector mutual funds in 1993 and the stringent regulations put in place by SEBI since 1996, the Indian mutual Fund Industry has taken off and since 2004 has evolved into a mature financial industry with Assets under management (AUM) of more than Rs 27 lakh crores at the end of 2019 (ref  In fact the AUM of Mutual Funds in India has registered a compound annual growth rate (CAGR) of 25 per cent over the five year period from 2013-2018, outstripping the CAGR of only 11 per cent registered by aggregate bank deposits of scheduled commercial banks during this period (ref Consequently the vast Indian middle class needs to wake up and re-condition its mindset and see-through the sharp sales pitch of Insurance agents who peddle Insurance products to them solely on the basis of tax savings.

Insurance is an entirely different requirement from Investing. Insurance takes care of the protection needs of the individual – due to sudden events related to life, job or health – whereas Investing addresses the topic of wealth generation for building a nest egg for your entire life. Therefore whenever Insurance is being sold as an Investment, you should de-link the Insurance need from the Investment need and only consider buying the Insurance portion (Term Insurance) to satisfy your protection needs and then invest the difference. Combining Term Insurance with Investments in the form of Savings plans or Endowment plans locks investors into long term commitments into products where there are expensive management fees and associated agent commissions which is a drain on the individual’s hard earned money.

The Finance budget for 2020 has taken a welcome step in this direction by giving taxpayers the option to decline these exemptions in order to avail a lower income tax rate. This is a soft signal from the Government that individuals are free to make their own choices for their saving requirements and should not rely solely on the tax incentives provided with Insurance products for this purpose. This option will force all taxpayers to now calculate whether they are better off availing the tax exemptions and paying a higher tax rate or declining the exemptions for paying a lower tax rate. In this process, the re-conditioning of the mindset to buy Insurance products solely for the purpose of saving tax will automatically take place. It is quite possible that existing investors who are heavily invested in Insurance products may choose to avail these exemptions. However new entrants to the job market and other young investors will certainly want to make their own savings decisions and avail a lower tax rate. Both classes of investors will do well to reach out to a qualified Registered Investment Adviser to guide them through this change.

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