INSURANCE ASSIGNMENT

LIFE INSURANCE AS AN INVESTMENT OPTION

SUBMITTED BY,

NELSON MATHEW

ROLL NO:0920214
 Everyone wants to do right by family, and life insurance is exactly that – a way to
take care of spouse, children, and other heirs or family members after death. In addition to
standard insurance, though, many policies are adding features that turn insurance coverage
into a form of savings, such as cash value life insurance. Are these policies a good
investment, or are there better ways to help savings grow?

On the surface, a life insurance policy sounds like a good idea. By paying into a standard
policy each month, it's possible to leave a large sum of money behind to support a spouse or
children for the foreseeable future.

Life insurance is often used as an investment for retirement planning. Basic life
insurance can be divided into two general categories, term insurance and whole life
insurance. When you buy term insurance, you pay premiums in exchange for a death benefit
over a specified period of time. This is the least expensive type of life insurance. Because the
death benefit is all that you get with term insurance, it's never sold as an investment.

Whole life insurance, also known as permanent- or cash value life insurance, not only
promises to protect you for your entire life, but also includes an investment – the cash value.
Initially, the premiums are higher than term life premiums, but later in life they become more
comparable and could possibly even be lower. With the excess premium paid over the actual
cost of the death benefit, the insurance company sets up an investment, which is known as
an accumulation account.

The appeal of whole life insurance as a retirement investment is its tax treatment of the
accumulation account. This money grows tax deferred, which means that taxes are postponed
on income and capital gains. Assuming that you need life insurance at all, the argument over
whether whole life insurance is a good investment basically centers on the question of
whether you would be better off buying an inexpensive term policy and separately investing
the additional amount that the whole life policy would have cost. In making that decision,
there are several issues that you should consider:

• Your ability to pay the premiums. First, you should determine how much insurance
you need. Next, you'll need to check the premium costs for both term and whole life
policies. If you can afford only the term policy, buy it. You should never skimp on the
amount of your death benefit.
 • The possibility that you might not be able to get affordable insurance later in life. As
potential health issues increase with age, this could be of major concern. If it is,
compare guaranteed renewable term policies with the price of whole life.

• Your willingness to shop for no-load (or, no commission) insurance policies. Unless
you buy no- or low-load insurance policies, the costs of whole life erode returns so
much that it almost always makes more sense to buy term insurance and invest the
difference.

Unfortunately, there isn't a cookie-cutter answer when it comes to using life insurance as part
of your investment portfolio. A clear benefit of investing in insurance products is the tax-
deferred treatment of the cash accumulation part of the policy. Of course, the higher your tax
bracket and the longer you have until retirement, the more valuable this benefit can be.
However, a very important disadvantage of using life insurance as an investment is the high
fees and expenses that make it difficult to compete with the returns of even ordinary security
instruments, such asmutual funds.

Weigh the pros and cons carefully when deciding whether life insurance has a place in your
investment or retirement plans. If it does, educate yourself and shop wisely, preferably opting
for low- or no-load products that will meet your needs.

Choosing life insurance products such as ULIPs as an investment option may not be a wise
thing to do, as complex fee structures may eat into your returns. Insurance products should be
chosen only for risk cover; all other features of insurance products are available in mutual
funds at a much cheaper cost.

Just sample this set of charges a typical unit-linked insurance policy may levy on you -
premium allocation charge, policy administration charge, mortality charge, fund management
charge, top-up charge, switching charge, partial withdrawal charge and surrender charge.

All these charges could eat into your investment returns substantially, which makes the case
for insurance policies as an investment option weak. Add to this the problem of mis-selling
by insurance agents.

First, the risk of death of the insured and resultant loss of income for the dependents;
this risk can be covered with an appropriate 'term insurance' plan; and
Second, the risk of the insured living longer and, hence, a need for pension for self and
family. This can be covered with an appropriate pension plan.

Insurance policies should be chosen to address these two basic risks. Beyond these, the
policies serve very limited purpose.

The investment part of any insurance product can be adequately addressed by mutual funds,
which are much less expensive and also rank much higher in disclosure levels - be it the
charges they levy, the periodic disclosure of the portfolio of their investments or the ease of
access of net asset values (NAVs).

Besides, comparison of charges, past performance and asset composition are much easier in
the case of mutual funds than unit-linked policies offered by insurance companies.

Conventional insurance products - non-ULIP products - are even worse than ULIPs in
disclosure levels, making them much more complex to understand.

The insurance regulator can do much more to improve disclosure standards of both
conventional and ULIP products, which is beneficial in the long term both for the industry
and the investors.

What are these charges?

The typical charges a life insurance policy may entail, and the broad range for each of these
charges are given below; a few policies and promotional schemes could fall outside this
range.

Premium allocation charge: This is the charge levied by the insurance company to cover its
expenses - agent commission, marketing and selling expenses, etc.

This is usually the largest charge levied on the insured and can range from 5 per cent up to
even 60 per cent of the first year premium, and typically about 5 per cent of the annual
premium thereafter. Compare this with the 2.5 per cent entry load typically levied by the
mutual funds, and you get the drift.

Policy administration charge: This is the charge levied for the administration of the plan -
printing and stationery, postage, maintaining customer call centres, etc., are covered by this
charge. Usually this is a small fee - about Rs 20 - levied every month.
But beware of some policies which levy policy administration charge as a per cent of sum
assured, while charging an apparently low premium allocation charge. A pure marketing
innovation to make the policy charges appear low, when in reality they are not.

Mortality charge: This is the charge that is levied to cover the risk of early mortality of the
insured, the very purpose why an insurance policy is taken. Ironically, this cost is among the
smallest charges levied - typically ranges from 0.2 per cent to 0.5 per cent of the sum assured
per annum, depending on your age.

Some policies offer a fixed per cent throughout the life of a policy, while others offer a
variable per cent, increasing every year till the life of the policy. The variable rates, while
starting low, could grow to very high levels, as one reaches advanced ages.

Fund management charge: This is the charge levied for managing your funds by investing
in equity markets, debt markets, government securities, etc., as per your choice of funds.

Typically, this charge could be 1-2.5 per cent of the funds managed.

Insurance companies claim that their fund management charges are lower than those levied
by mutual funds.

But in the absence of appropriate disclosures, and lack of uniformity even within the same
insurance company across products, such claims can neither be confirmed nor denied.

Other charges, such as for top-up, switchin, partial withdrawal and surrender, are levied only
when the insured opt for any of these modifications to the original contract. Some of these
charges are punitive to ensure continuity of the policy and to deter frequent change requests.

Take, for instance, top-up charge. This provides some avenue for savings. Many policies
have high premium allocation charges, but low top-up charge. An investor could choose a
low initial premium, and opt for top-up to minimise the expense.

But then, why choose insurance policy as an investment, and then try to optimise your costs,
when mutual funds offer much better flexibility on all these fronts?

The mis-selling menace

Having interacted with almost all major insurance companies and a host of agents across the
spectrum, I have come across several mis-selling techniques adopted by agents to lure
unsuspecting investors. Here are some:
Selective disclosure of past performance: In the absence of appropriate disclosures and
rigorous comparisons of past performance by independent agencies (such as mutual fund
awards for the mutual fund industry), comparison of past fund performance becomes a
challenge in the insurance industry.

This leaves large scope for the insurance agents to selectively quote periods when their fund
performance was superior to an index performance and, thereby, hoodwink the investor.

Indicating much higher returns than permitted by regulator: The insurance regulations
permit benefit illustrations with returns only between 6 per cent and 10 per cent per annum.

However, many agents provide illustrations with much higher returns with impunity - some
even as high as 30-40 per cent returns in equity schemes citing performance in 2006 and
2007.

Even a small 2 per cent variation in annual return can show widely divergent terminal
benefits when compounded over long period of time, luring gullible investors into believing
they will be crorepatis in just a matter of time.

Promoting the policies that earn them highest commission: With scant regard for the
needs of the insured, some agents promote only policies that can earn them the highest
commission. Premium allocation charges are substantially lower in single-premium products
(as per regulation) and, hence, commission earned by agents are the lowest in this class of
policies.

Suggesting deliberate discontinuity in premium payments: Few unscrupulous agents even

suggest discontinuing existing policies and opting for new ones, because that earns them
much higher commissions. In fact, one large insurance company had policy forfeitures of up
to 30 per cent of new policies in their second year, prompting an investigation and reprimand
by the regulator.

Promising kickbacks: The oldest trick in the book, many agents still promise to pay the
insured some portion of their commission earned, despite stringent regulations prohibiting
this practice. While this will apparently reduce the 'charges' borne by the investor, little do
they realise it is their own money coming back to them illegally, subverting the good
intentions of the regulator.
SOLUTION

The regulator can ensure standardisation of some of the charges - for surrender, policy
administration, switching, etc., and disclose ceiling on other charges - fund management
charges, policy allocation charges, etc.

The regulator can also engage in more proactive regulation - dialogue with insurers on
specific regulatory provisions will yield better results, than making the regulation more and
more complex to address every possible mis-selling situation.

The insurance industry can promote a self-regulatory organisation (SRO) that compiles and
discloses NAV and periodic portfolio (like AMFI does for the mutual fund industry).

Insurance companies can promote 'risk cover' as their key offering, and give more thrust for
term assurance policies (where none of these charges are pertinent as the entire premium
belongs to the insurance company).

Insurance companies can also modify their incentive schemes for agents to maximum the
'sum assured' - which is the main purpose of an insurance product, rather than maximising the
charges earned by the insurance company. In fact, even shifting to 'employee' model rather
than 'sales agent' model and reducing variable pay could help insurance industry in the long
run!

Insurance company angle

The accusations that are being made are not new to the insurance companies. And they do put
up a stiff argument to defend these. Some common lines of defence are:

Higher charges in insurance (when compared to mutual funds) are because insurance is a
complex product and takes effort in selling.

Despite these charges, long-term investors may benefit more from insurance policies than
mutual funds because fund management charges in insurance products are lower than mutual
fund products.

Insurance policies discourage easy redemptions and help investors stay invested for long term
in a disciplined manner.

Mis-selling is beyond their control in a situation of rapidly expanding base of agents.

While there is merit in some of these arguments, insurance companies, regulators and the
intermediaries can do much more for the long-term health of the insurance industry.