Insurance vs Investment for retirement

planning
Almost everyday people get calls and messages from insurance companies
trying to sell some sort of insurance plans that promises to not only provide risk
coverage but also provide you with some sort of investment. Pay Rs. 10,000 per
month for 30 years and get an assured some of Rs. 1 Cr on retirement or some
other similar plan that promises to pay you monthly pension once you decide to
retire. Whether putting your money in these kinds of plans really makes any
sense from a financial perspective, is what I will try to answer today.
Before we move into whether these policies are good or not, it is important to
understand what exactly are these kinds of insurance policies. Generally,
insurance is just supposed to be a risk covering mechanism, and that is true for
the most part. Insurance can be broadly divided into two parts, namely General
Insurance and Life Insurance. Life insurance deals with the risk associated with
ones life, mainly in the event of death. Every other kind of insurance falls under
the category of General Insurance, and chances are that no general insurance
plan will ever give you any form of investment option. In fact, all of them are
structured in the form of annual renewal plans, where you pay annual premiums
just for risk coverage and you can renew your insurance by paying the premium
again in the next year and so on. The premium you pay is pretty much an
expense for you. It is only the life insurance policies that may offer you some
investment opportunities along with risk coverage. These policies are also
referred to as Growth Plans, where the premium you pay includes some part as a
pure risk premium and the remaining part is treated as investment premium
which the insurance company invests on your behalf and they pay you back after
the maturity of the policy either as a one-time payment or with a pension like
payment structure. There is also a normal kind of Life insurance apart from these
growth plans, which is called Term plans, and they are like general insurance
policies in the way that you pay annual premium just to provide a risk coverage
and the premium is a pure expense and you will not get any money back unless
something happens to the person insured. You renew your cover every year and
that is about it.
The whole argument as to which kind of life insurance plan might be better for
you comes from the fact that premiums for both these kinds of plans differ
significantly. For a risk cover of about Rs. 1Cr you might have to pay 10,000
every month in a growth plan for 30 years, and for the same duration of 30 years
and for the same risk coverage, under a Term Plan, you might only be paying Rs.
1,000 every month. This is almost ten times less than the premium amount you
pay for the growth plan. The whole argument boils down to the fact, that how
much return on your investment are you getting with the growth plans and is it
worth investing your hard-earned money in such kind of policy, when you can put
your funds in other forms of investment with lucrative returns.

Putting Numbers to Facts:

Let us look at it objectively, using some basic financial principals we can
compute that over 30-year period, a growth plan paying you 1 crore and
assuming 10,000 monthly payments is giving you a return of around 6% per
annum. Even if you bump the sum assured to 1.25 crores in case of some
competitive insurance companies, you are still looking at somewhere close to 7%
return on your investment. Now take an example of a term plan that requires you
to pay 1000 per month just as a risk premium for a similar risk coverage. This
means that you are left with 9000 every month that you can invest in other
financial options that might give you a higher return for your investment. Just in
purely mathematical sense, this 9000 per month must earn at least 7.7% per
annum to make it equal to the growth plan in terms of its total return. So, the
number to beat is 7.7% p.a.
Now let us look at what other investment options does a person have. The first
one of course if investing and the money yourself by doing market research and
becoming your own wealth manager. Probably not the most practical idea, and
not applicable to most people since not everyone has an expert level knowledge
of the finance world. This is where wealth management options come into play.
Put the money into a Mutual Fund or an SIP. They are basically a big pool of
money of people just like you and are managed by professional portfolio
managers and wealth management experts, and the best thing is that they are
governed specific to the risk profile of investors. Some Funds are only based on
Equity which gives higher return but is also a bit riskier, and on the other
spectrum are Funds operating only in Debt Market, which is low risk and low
return. Over last 3 years the worst performing Debt based Funds in this country
have given a return of 7.73% to its investors and the story keeps getting better
as you move to the better performing debt oriented funds which have a return of
around 13%, and Equity based funds have return as high as 20% for reputed
Mutual Fund Companies. Considering that both growth plans and Mutual funds
have their respective tax benefits, the numbers pretty much speak for
themselves. But let us for a moment assume that investors dont want their
money managed by some investing strategy of a Fund Manager or a Wealth
manager, but want a more secure portfolio. The best options are Index-Based
Funds, which invest in the same weight as in case of Market Index, so your
investment moves in the same direction as that of the Index like Sensex or Nifty.
The best thing about investing using Index as a benchmark is that while in the
short terms there might be years where the index gives negative return or a very
low return, in the long run Indexes have always given huge returns to the
investors. From year 2000 to the year 2016, the Index has shown a growth of
over 11% p.a. rising from 3972.12 at the close of 2000 to 26626.46 at the close
of 2016. Given that our required investment horizon is of 30 years, relying on the
growth statistics of the Index makes the most sense.

Conclusion:
So, the numbers do justify the fact that an Insurance Policy is not a proper
replacement for an Investment Plan from a pure financial perspective. But
Growth Plans are not out of place either in the existing financial environment.
They just serve a different requirement. They do have less risk compared to any
investment made in the market, but the decision is not about which option is less
risky, it is about deciding what options suits your risk profile better, and it is
probably justified to take just a little bit of risk for such high return. Just to put
things in perspective, investing 9000 a month for 30 years in an Index Based
funds gives you well above 2.5 crore at the end of 30 years as compared to even
1.25 crore that only a few insurance companies offer. Getting almost double the
amount for the same duration is worth taking the risk in almost every case. In
fact, just putting the same money in your savings account earning 6% p.a. will
give you 90 lakhs after 30 years (but there might be tax complications with this
method). If you are going to take a bit of financial risk, it makes more sense to go
with a pure investment plan to earn you money and to leave insurance just as a
measure to cover the life risk.

-Shubham Goyat
Disclaimers/References:
1. All data regarding Insurance policies was collected form policybazaar.com
2. All date about returns of various mutual funds and Index funds was collected
from moneycontrol.com and economictimes.com