It was a beautiful day, it was the day when Rishab Singh got the news that he and his wife became a proud parent of an angelic girl child. Rishab was happy beyond bounds and distributed sweets to one and all he met that day. One of them Aarush, who he met that day was a friend of family friend, was an agent of a Life Insurance company. He shared Rishab exuberance and handed over his visiting card to him.
A week went by with Rishab and his wife Tara Singh busy with tending to baby girl needs when Rishab’s phone rang. After picking the phone Rishab realised it was Aarush who was calling to see if he could seek time with Rishab and his family. Although the Singh family were busy they called over Aarush to their place. Aarush came to meet and over the course asked the couple how they are planning to secure the life of baby girl as now they have added responsibility of raising a child and secure her future with money required for her marriage or for her higher education.
As the couple was clueless about same Aarush told them about a “savings cum insurance plan” or in other words an endowment which could help the couple achieve future security of child with sum assured as survival benefit at the end of maturity period (till the child attains age of 18 years) along with insurance cover during the term of the policy and put a cherry on the plan provides an additional tax saving benefit. This was too good to be true an offer and the couple readily wrote a cheque to the company offering the plan along with the filled up application form. Is this a case of a family friend offering free financial advice to a family in need or was it a case of an unscrupulous insurance agent preying on gullible customer? To help you assess same let’s dig deep and then perhaps at the end you could make a decision for yourself.
Let’s deal with Insurance 101 to understand why one would need a life insurance plan? An insurance plan is primarily required to protect a source of income as any impairment of this source due to loss of life would result in financial difficulties for the dependents as their expenses and investment required to achieve future goals would be impacted. In layman terms that income source is a family member or members on whose income the family depends to run its expenses and saving for future requirements.
The child in case of Rishab’s family is not an income generating member so does she need life insurance cover? So instead of buying an endowment policy for her aren’t Singh family better off instead by investing the annual premium amount in either long term mutual fund or to keep it simple even a term deposit with any scheduled banks? To get a better grip of issue on hand let’s illustrate with an enclosed table illustrates a comparison between existing endowment plan and option to invest in equity mutual fund.
Above comparative calculation is based on premise that a non-income generating family member does not require life insurance and that the parents are not dependent on child’s income in future till she attains adulthood at which point the existing endowment policy would mature. Aarush as a sponsor of the insurance policy is paying annual premium to the tune of nearly INR 45,000/- and this payment would continue for 17 years. On a back of the envelope calculation itself the Singh family would pay ~ INR 7.7 Lacs as premium over the term of policy for a sum assured of INR 10 Lacs.
Further, Singh family requirement is primarily trying to secure the child’s long term future, hence we are assuming an asset which could fulfil the family long term goal would be apt for this purpose. One of the asset which meets these criteria apart from other asset class is equity and long term average return on equity investment in India comes around 12% on a conservative estimate. To keep things on an equal keel let’s assume that Singh family invests in ELSS (Equity Linked Savings Scheme) Plan, as just like the endowment plan ELSS too offers tax benefits under Sec 80C of Income Tax Laws on invested amount. Even with Long Term Capital Gains (LTCG) beyond capital gains of INR 1 Lac putting money in an ELSS Plan till Year 15 (as ELSS have lock-in period of 3 Years) and for rest 3 years Singh’s can invest INR 45,000/- in Term or Fixed Deposits with expected pre-tax return of around 4% . Option B would probably win hands down (based on past returns from equity investments) as compared to putting same money in existing Option A by a factor of nearly 2 to 1 on a post-tax return basis.
Although the expected event is still 18 years away so we are still speaking hypothetical returns on invested money but I hope you got what we are trying to tell you – separate insurance from investment especially when the outlook is long term. Tell us your views about same and in future we would incorporate those views and carry the discussion forward till then let’s start asking the question you are in agreement with Singh family on their decision or do you differ with their decision?
Abhishek Kumar is a SEBI Registered Investment Adviser (Registration Number: INA100008045) since July, 2017. He is an MBA from IIM Bangalore and has worked with companies of repute such as Dell, Accenture and IBM in his previous engagements. An avid reader and commentator on anything under the sun. He is available for advice on specific financial planning needs on [email protected]