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My name is Insurance and I am not an Investment

With due apologies to Mr. Karan Johar, inspiration for the above blog title comes from his movie tagline 'My Name is Khan and I am not a terrorist'.

My name is Insurance...
... and I am not an Investment

Or, rather it would be apt to admit
... and I am not a "good" Investment

Why?

Firstly, your primary expectation from any investment is to earn GOOD returns. And I definitely fail on this front.

When you give me your premium, out of Rs.100 about
- Rs.2-4 goes towards providing you the insurance cover i.e. mortality charges,
- Rs.10-15 is paid out as the agents' commission, and
- Rs.3-5 is spent on fund management and policy administration.

Thus, you lose Rs.15-25 as soon as you pay me the premium and only Rs.75-85 remains as investable amount. Instead, with bank fixed deposits, bonds, debentures, debt mutual funds, PPF, EPF, NSC, etc. your investment amount remains at Rs.100 or thereabout, as most of these carry "zero or minimal" charges.

Since the money is finally invested in the same debt market in India, it will earn more or less the same returns. However, as your 'net invested amount', after deducting all costs, is lower in insurance, it is but natural that on maturity you will receive a lesser payout as compared to any other aforesaid product.

In other words, while your effective returns from insurance would typically be in the range of 5-7% p.a., other investments would deliver around 7-9% returns.

I am sure you don't prefer earning such poor returns.

Secondly, I offer very poor prospects of liquidity vis-a-vis others.

I believe in long-term relationship, generally extending to around 10-20 years. Moreover, it is a one-sided affair. During this long tenure, you cannot depend on me to help you even if you are in dire and urgent need of money. If you surrender your policy, I will give you not even half of your accumulated corpus (unless the relationship is nearing maturity).

Other investments are lot more understanding and accommodating. With them, you will be able to 'prematurely' access your money with minimal damage.

Thirdly, I am an extremely rigid fellow.

If you fail to pay even a single premium over the 10-20 years of policy tenure, I will cancel your policy. I demand complete and absolute commitment.

With other investments, you have the flexibility to change your amount every year based on your financial circumstances. If you are going through difficult times, you could always cut down on your investment. Alternatively, when you are making good money, you can increase your outlay.

Of course, I enjoy lot of trust because I am considered "risk-free" and "tax-free".

But, frankly speaking, this edge over others is neither unique nor useful.

If you have a tunnel vision and believe that an investment is risk-free only when you are assured of receiving your money back, then I am risk-free. But default-risk is not the only risk in life. Given the poor returns, I offer no protection against the inflation-risk. Plus, without going into the nitty-gritty, debt mutual funds offer excellent opportunity to benefit from the interest rate movements, whereas with me you will also suffer from the interest-rate risk.

Yes, the returns that I offer are tax-free, while most of the other investments attract tax. However, PPF and EPF are tax-free. Moreover, even with the 'taxable' debt mutual funds this advantage is lost. With indexation benefit over 3-5 years, your returns from debt funds too would become practically tax-free.

Thus, I the Insurance, hereby declare that I am not a 'Good Investment'.

[Note: For simplicity, I have focussed on the currently more popular traditional insurance plans such as money-back or endowment. I haven't discussed the ULIPs, where you have the option to invest in equity too. They do not suffer from the aforesaid deficiencies as seriously as the traditional plans. However, they still don't just match up to their closest rival and competitor, the equity mutual funds.]

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