Do not mix Insurance with Investments

We are into the month of March – the last month of the current financial year. Tax planning is now uppermost on the mind of those who feel this is their last chance to save some income tax for the year. This urge to save taxes makes them highly gullible to the pointed sales pitch of ever available and savvy insurance agents who are on the prowl to ratchet up sales of their insurance products (endowment plans, savings plan, ULIPS, etc) in the guise of saving taxes for their clients. The lure is that most such insurance products are bundled as investments and promise to give back some multiple of the total premiums paid. Investors see a double benefit – tax savings plus money back at the end of the term. Consequently they are already sold and so quick to sign up for these products that their checks are already signed – they are just waiting to fill in the premium amount. This is how the vast majority of Indians are enticed into subscribing to sub-par investment products with hefty annual premiums for the meager purpose of saving a little tax. What they fail to realize is that by buying such products they neither get adequate insurance cover for themselves neither do they secure their future by way of making good investments. Lack of adequate regulatory prohibitions from bundling insurance products only makes it worse – ensuring this saga continues year after year.

The fact of the matter is this – Insurance does not equal Investments.

Let this message sink into your conscience through the above picture. Think of Insurance as an umbrella that protects you from unforeseen and sudden events. And think of Investments as an inverted umbrella that helps you accumulate and multiply your savings for a comfortable future. Do not ever mix the two – no matter how much the Insurance agent tries to convince you.

Insurance is a protection product and term cover is the purest and cheapest form of Insurance cover there is. That is the only form of Insurance you should consider buying – ideally for a sum assured of up to 10 times your annual income – to protect your dependents in the unforeseen event of any eventuality to your life. There is a cost that you have to pay for availing this protection - the annual premium. Think of this premium as an expense to protect your dependents if something were to happen to you. Do not be tempted by clever sales pitches that promise to recover this expense at the end of the term plus guaranteed additions plus reversionary bonus plus terminal bonus plus god knows what else. These sales pitches and the associated products are designed exactly to target your weak spot – your lack of willingness to treat Insurance premiums as an expense and your greed to recover this money at the end of the term. By succumbing to this greed you will end up owning products that neither gives adequate life coverage nor optimal investment returns. What makes it worse is that these are multi-year commitments which are often difficult to exit without talking a significant loss.

So the next time you are pressured by an insurance agent into buying such a product and are in doubt, ask for more time and then contact your financial advisor for a second opinion. Understand for yourself the tradeoffs between buying a bundled product versus buying a plain term plan and investing the rest of the money. Read The 4 ps of personal financial planning to understand how to go about planning your life’s finances in your own best interest.

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 https://en.wikipedia.org/wiki/Income_in_India). 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 https://www.amfiindia.com/indian-mutual).  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 https://rbidocs.rbi.org.in). 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.