Tuesday, July 31, 2007

Trashing the term insurance plans

While I have earlier reasoned why I am sticking to my Ulip plan, here I am trying to bust the myth that a combination of term insurance and mutual fund is good for an individual.

Lots and lots has been written about Unit Linked Insurance Plans (Ulips) being a bad product as compared to a combination of term insurance + mutual funds. What I tried to examine is if the term insurance products are really that good for an individual. I am not going to repeat the calculations here, since they are freely available in thousands of financial advice sites over the Internet.

You have to necessarily pay to continue with the life cover
Most pure term insurance products are based on the assumption that you will continue to pay for the whole duration of the term. Which means that if you don't pay your life cover will be terminated, albeit after a grace period in which you can revive the policy. While the same revival benefits are available, what is attractive about ULIP plans that after a certain number of years, depending on your accumulated fund you can withdraw enough to actually pay the Annual Target Premium (ATP).

Loss of capital
Pure term insurance does not give you any maturity benefits. Which means once the term is over and the life insured is still alive, they will thank their gods and won't even say a good-bye to you. They have pocketed your money, but no thanks. In case of ULIPs, after deducting the mortality charges the rest is invested, so you get back something.

Nobody buys pure term insurance
Yeah, that's true! And not because we are not educated, but because we are not financially educated and we are hell lot emotional. So when a person is faced with loss of capital, they tend to go in for money-back plans, endowment plans, etc. Such plans have a fixed term and the insurance house may declare bonuses in between or promise a lump sum amount at the end. People like such products because they want to be able to insure that their children get the education they want, or their retirement funds are guaranteed. If that is the case then why waste good money on such traditional products which promise at the max a return of 8% as opposed to the equity linked product which can potentially give a higher growth.

Taking advantage of your short-sightedness
No doubt that the way some of these insurance products are positioned are in a very bad taste. What the general public must realize that Ulips are long-term products as opposed to mutual funds. Even if you are going in for the equity linked saving schemes (ELSS), it's very easy to spend the money either because you want to buy something, or some emergency has arisen for which you need funds. But in case of Ulips, its a yearly or some such periodical payment option. Now most generally people have the insurance payment budgeted over and above the emergency funds. But how many people budget investment?? And thus it becomes very easy to spend that money that you get from the mutual fund. It is the same reason why I dislike the money back plans amongst the traditional insurance plans. And the this thing as a whole is detrimental to long term wealth building, which many of us are not able to see for us.

Read the fine-print
The pitch that any financial planner will make to you is, ULIP's are high initial cost products, almost in the range of 30%-65%. Now if you add the power of compounding to it, it represents a huge loss of income in one's lifetime. Well, those figures are wrong. Any good insurance house would have charges in the range of 40% and less and that too for the first year only. And it's not as if they sneak out that expense. It is clearly mentioned in all brochures and illustrations that they come out with.

The conspiracy
Yes, I believe that there is a conspiracy by the financial planners and mutual fund houses. In recent years the growth of the market linked insurance products have managed to attract more capital than the regular mutual fund industry. In fact this debate started when the Indian government decided to increase the limit on tax saving insurance premium payment. Earlier as per the Indian Income Tax laws, a yearly payment of Rs. 10,000 only was tax deductible under premium payment for insurance plans while it was higher at Rs. 30,000 for equity linked saving schemes. Then the Indian government went ahead and clubbed both under the same bracket and raised the combined limit to Rs. 1,00,000. Now the mutual fund industry saw red all over. Then somebody comes along and suggests, "Let's build a cartel of financial advisers who will keep trashing the ulip products and simultaneously build the reputation of the mutual fund industry." Voila! and that day onwards it has been that way.

My 2-paisa conclusion: Long term wealth building is all about controlling your emotions and getting educated in finance. It has nothing to do with which product you choose. Even the greatest of all investors and father of value investing, Benjamin Graham, suggested that you have a certain percentage of your portfolio in high grade bonds. Start early, make a plan and stick to it! That's all that is there to it.
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