Mixing investment and insurance: Finding the right balance for your needs

Age, returns and security are some factors you must consider before your purchase a plan

Relationship managers and agents' work is to pitch insurance products. Many people may struggle to decide if it is the right product for them. Here is a roadmap to help you make the right purchase.

There are two types of investment-cum-insurance plans: linked and non-linked.

Linked: Your money is invested in capital markets and the return is linked to the performance of those investments. Unit-linked insurance plans (ULIPs) are linked products.

Non-linked products: The returns are not linked to market performance. Traditional plans are non-linked and they have two variants: participating and non-participating.

Participating plans get a share in the profits of an insurance company. Non-participating traditional plans and ULIPs do not.

Non-participating (traditional): These plans are non-linked and offer guaranteed returns, giving certainty about returns. You can calculate their returns upfront (or get an advisor to do it for you). If the insurance company survives, you will get the promised returns. You need to calculate if the return is high enough for a long-term investment.

By searching for key terms in a brochure, you can figure out the kind of plan you are being sold. They are available on the first or the second page of the product brochure.

There is one aspect you must be careful about. In all investment-cum-insurance combo products (traditional plans and ULIPs), the returns depend on your age. Everything else being the same (policy, annual premium, sum assured, policy term, premium payment term, variant), a younger person (at the time of entry) will earn higher returns than an older investor. Older investors must be wary about investing in such products, as a large portion of their premium will go on paying the cost of the insurance component. This will reduce the amount invested.

Older people should be careful that they are not being pitched the benefits offered to a younger person. You can generate an illustration for your age from the insurer’s website.

Participating plans and ULIPs can’t guarantee returns. If a seller tries to give you the impression that these plans will offer guaranteed returns, be wary.

In participating plans, your final returns will depend on various kinds of bonuses (simple reversionary bonus, final additional bonus, loyalty additions, terminal bonuses, etc). The nomenclature can vary across plans. These bonuses are not guaranteed as they depend on the company’s performance.

ULIPs

In ULIPs, your money is invested in the capital markets (like in mutual funds) and your returns depend on the performance of those investments. Again, no one should offer a guarantee in ULIPs. Since ULIPs are market-linked products, their returns can be volatile.

ULIPs are of two types: the difference is in the death benefit. Under Type I ULIP, the nominee gets the higher of the sum assured and fund value in the event of the policyholder’s demise. Under Type 2 ULIP, the nominee gets the sum assured plus the fund value on the policyholder’s demise. Read information about death benefit in a policy to know whether you are buying a Type-I or Type-II ULIP.

Since the death benefit is higher in Type 2 ULIP, the cost of insurance is higher and this influences returns. If you are buying a ULIP for investment, go with Type 1 ULIP. If you are buying it to bridge a serious gap in life insurance coverage, got for a Type 2.

It is advisable to stay away from traditional plans and ULIPS. The reasons are high cost (especially if you buy through an intermediary); low returns for a long-term investment (though this is subjective); and lack of flexibility (premature exits are usually expensive).

Nonetheless, some investors do buy such products for a variety of reasons: lack of financial knowledge, inability to calculate the true returns from a product, hard-selling, and so on.

There is one more reason for their popularity. Most investors seek comfort: A 50-year-old may invest Rs 2 lakh per annum for the next 10 years (until the age of 60) so that he can get Rs 2 lakh per annum from the age of 60 until 90. He is not bothered that the returns from this 40-year investment is only 6.3 per cent per annum. Or he may not even know that the product will give 6.3 per cent per annum. For his peace of mind, he is willing to settle for sub-optimal returns.

People could mock the financial wisdom of such investors but that is unfair. The investor’s perspective should be considered.

Investment, insurance

What should you do? Do not mix investment and insurance. However, if you must do so, understand the product properly before buying.

If you buy a participating plan (where the returns are not guaranteed) thinking you are buying a non-participating plan (where the returns are guaranteed), then there is a problem.

Similarly, while both participating plans and ULIPs do not guarantee returns, it does not mean their risk profiles are similar. ULIPs are far more volatile. Do not buy a ULIP when you are looking for a traditional plan or vice-versa. Do not buy a participating plan or a ULIP when you are looking for guaranteed return. Buy a non-participating plan instead.

Do not buy a traditional plan when you have high return expectations. A ULIP would be a better choice. Do not buy a ULIP when you want a stable (albeit low) return and low volatility product. A participating plan might be a better choice. 

(Deepesh Raghaw is a Sebi registered investment advisor (RIA) and the founder of PersonalFinancePlan.)