Assignment on Insurance

Topic: Is life insurance a good investment.

Submitted By : Ashim Mandal

Reg No : 0920106
MBA B

Submitted to:
Prof. ND

CHRIST UNIVERSITY
INSTITUTE OF MANAGEMENT
INTRODUCTION
Life Insurance is a contract between two parties (Insurance company and Insured person) and
it is enforceable by law. 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 other policies available are Endowment Policy : Combining risk
cover with financial savings, endowment policies is the most popular policies in the world of
life insurance. Money Back Policy : These policies are structured to provide sums required
as anticipated expenses (marriage, education, etc) over a stipulated period of time. Annuities
And Pension: In an annuity, the insurer agrees to pay the insured a stipulated sum of money
periodically. The purpose of an annuity is to protect against risk as well as provide money in
the form of pension at regular intervals.

Over the years, insurers have added various features to basic insurance policies in order to
address specific needs of a cross section of people.

So except term insurance and whole life insurance, all other policies are augmented model of
insurance and investment. While insurance and investment has their separate purpose to serve
in personal finance, most of the times, insurance policies fail to match the expectat

REASONS FOR HAVING LIFE INSURANCE

Life insurance serve two basic purposes:

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.

HOW TO DECIDE
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.
• Your federal and state tax brackets. The benefit of a tax deferral is only as valuable as
the amount of taxes that would be deferring. The higher your tax bracket the more
valuable the benefit is.
• 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 as mutual funds.

Permanent life insurance products are not normally considered a good investment. However,
it is possible to make them so if certain conditions are met. It is often possible to structure the
components of a permanent insurance product to reduce the traditional agent’s commissions
by approximately 85 percent. Permanent life insurance deserves serious consideration in a
variety of investment, estate, and business planning situations, given the ability of a low-cost,
well-performing policy to beat the risk-adjusted returns of comparable investments by
significant margins. Hence, for the very wealthy, domestic private placement and offshore
life insurance policies, offer broader investment options and the possibility of additional
savings on policy expenses in comparison with standard variable life policies using registered
securities products.
WHAT ARE THE CHARGES IN LIFE INSURANCE POLICY?
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.

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, switching, 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.
INVESTMENT VS LIFE INSURANCE

A person does buys an insurance policy to avoid losses from uncertain incidents, but does
investment to earn better return to achieve some financial goal in short term or long term. A
good investment is that which will give better than Government bond returns (at least). Also
the tim value of money is also needs to be considered and the investment should give better
return than the inflation rate. In the following example we will see what return a life
insurance policy gives to a person.

An Example

Company: Kotak life insurance term plan and Kotak life insurance Endowment plan.

Premium for endowment plan: Rs 132138

Premium payment period: 5 years

Policy term: 24 years

Sum assured: 1000000

Expected Bonus: 80% of sum assured or Rs 800000

Rate of discount: 10%

Present value of the premiums:

Premium Present
Year paid Value
0 1,32,138.10 132138.09
1 1,32,138.10 120125.54
2 1,32,138.10 109205.03
3 1,32,138.10 99277.30
4 1,32,138.10 90252.09
Total Present
Value 460745.98

Present value of the sum assured: Rs 101526 + Rs 81221 = Rs 182747

Net Present Value= Rs 182747 - Rs 460746= (-) Rs 277999 (Loss)

So the insured person is actually incurring a huge loss buying the policy.
 In other option if the person takes term insurance every year for the same sum assured but
with much lesser premium and invests the excess amount in some other avenue such as
mutual fund, equity etc. the returns will as follows:

Premium for term insurance: 12791

Sum Assured: 1000000
Investment return: 10%
Discount rate: 10%
Premium Value of the No of years
for Premium Present investment at the amount
endowment for term value of this Excess the end of the remain
Years policy policy premiums amount term invested
0 1,32,138.10 12791 12791 1,19,347.10 1175536.99 24
1 1,32,138.10 12791 11628.18 1,19,347.10 1068669.99 23
2 1,32,138.10 12791 10571.07 1,19,347.10 971518.17 22
3 1,32,138.10 12791 9610.06 1,19,347.10 883198.34 21
4 1,32,138.10 12791 8736.42 1,19,347.10 802907.58 20
5 12791 7942.20
6 Value of
12791 7220.18
the
7 12791 6563.80 Investment
8 12791 5967.09 after 24
9 12791 5424.63 years 4901831.09
10 12791 4931.48
11 12791 4483.16 Present
12 12791 4075.60 value of the
13 12791 3705.09 investments 497661.33
14 12791 3368.27
15 12791 3062.06
Present
16 12791 2783.69 value of the
17 12791 2530.63 term
18 12791 2300.57 premium 126416.24
19 12791 2091.43
20 12791 1901.30 Net present
21 12791 1728.45 value 371245.08
22 12791 1571.32
23 12791 1428.47
Present value of the term
premium 126416.24

Here the NPV is significantly higher.

So the insured person should buy term insurance instead of life insurance and the remaining
amount he should invest in other appropriate investment horizon.
THE MIS-SELLING MENACE
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.

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.