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 ₹ 10,000 per month for 30 years and get an assured some of ₹ 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 one’s 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 ₹ 1 Cr 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 ₹ 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 payment’s is giving you a return of around 6% p.a. . 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% p.a. 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 don’t 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 lac 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