Shall I be going to an Eye Doctor?
When was the last time you went to your eye doctor to lose some weight?
Well, you probably didn’t. And even if you did, your eye doctor probably looked at you quizzically, shrugged her shoulders and asked you to go to a gym instead.
If this seems so obvious, I am puzzled as to why smart, educated and super-achiever folks can’t figure out the difference between ‘insurance’ and ‘investment’.
Insurance, in my limited opinion is the action to protect one’s assets – be it property, health, or life.
So, if I have bought a new car and have put a substantial amount of my hard-earned money into it, I will make sure that it’s safe and secure and doesn’t get stolen. But cars do get robbed and hence there is something out there called Insurance – to protect my investment. So someone in the big bad world is ready to take a risk of my car getting stolen and compensates me by buying a new car for me, in return for a very small sum of money (premium) that I pay every year.
How do they benefit? Well, they collect these small sums from lots of folks and have a simple calculation that everyone’s cars won’t be stolen together – so the money that they collect from lots of premiums is ‘more’ than the cost of replacing a few car/s. In doing this business, the Insurance Company lands up making a profit (in most cases, unless all the folks they insured lived in Bihar). (Bihar is a state in India in which politicians and local goons rob cars as a matter of fact).
This business applies to Life Insurance, Health Insurance, Art Insurance, etc.
Did you know that if you reserve an expensive boat cruise by paying upfront ‘non-refundable’ money, there is an insurance protection that can help you recover that money in the case if you change your mind and not go on that cruise! So the insurance folks by offering this policy have figured out that lots more folks finally go on that vacation than those who back out! Similar Insurance folks have understood that Beckham’s knees won’t break or George Clooney will not lose his voice and hence ‘insure’ these stars by guaranteeing large sums of moneys if these bad things were to ever happen to them.
‘Investments’ in my mind is the surplus money that you save and put aside from your hard-earned monthly earnings so that you can a) protect your money and b) earn decent returns on it depending on your risk appetite. So, if you are a monk, you go in for bank deposits and savings accounts and if are a cowboy like me, you play the stock market.
Pray tell me, how and where is the scope for insurance and investment to be the SAME thing? In the past 15 years of meeting insurance folks, I have asked them this question and have never received a convincing reply!
Some points:
- Insurance premiums DON’T have to come back to you as ‘bonuses’ etc!
Think of them as the fare to take a taxi ride! A few years ago I bought a ‘term’ life insurance. The logic was simple – if I were to suddenly decide to take a rocket and meet God, my family whom I would have left behind, would have been paid a good sum of money. If I decided to stay and not to ride that rocket (and I didn’t), I would continue to pay the insurance company a premium that they would never be returned to me!
- Don’t buy insurance to save TAX!
Now, that’s one of the most confusing and bewildering reasons I have come across, when it comes to buying Insurance. A large bulk of Indian Insurance policies are sold in the Jan-March quarter thanks to the zillion of agents out there who suddenly descend on hapless folks and get them to sign up insurance deals to save taxes…
Think of it like this – imagine you have been shipwrecked on an island and have a 100 bananas (earnings) with you – the island money (tax man) will take away 30 (tax rate) and let you survive on the remaining 70. It’s logical to live and let live. Most folks however, want to bury the 100 bananas, wait for the monkey to disappear (suffer the the 3 -7 year lock in) and then dig the bananas back from the ground, to eat them all by themselves!
Sorry! It doesn’t work that way! The present day benefits (think Net Present Value) of the bananas are not the same after 3-7 years ( factor in poor returns on the locked money and the corrosion of value thanks to inflation)!
This para is inserted post original posting thanks to Reem who bought the topic of taxes to my attention – see his comment at the end.
- Understand the concept of ‘IRR’ thoroughly
it’s the calculation of MONEY OUT and MONEY IN over periods of time and what you did finally EARN in the end. This is the way car EMIs are calculated – do your own calculation for the moneys you are paying out annually (premiums) and what you will get back when all your hair turns white. In almost all cases, you will be shocked at the pathetic return. (Just google IRR and Insurance)
- Be demanding on both fronts.
The problem with these ‘insurance cum investment’ policies is that you DON’T KNOW what to demand from whom. It’s like going to a friend’s house who serves you bread and butter to fill your tummy up. You can’t DEMAND that your friend serve you a 3-course meal coz you went to the WRONG PERSON for the WRONG PURPOSE. So, go to a restaurant for a great meal and torch their pants if they fail – and go out for a drive with your friend and demand that she sings a song to you on the way coz in both cases the demand you make is reasonable!
The era that we live in has a specialist and a service for every wish you may have. So, don’t ask the plumber to repair your Wifi Modem – the Linksys guys are meant for that.
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You are bang on! four years back I wanted to buy (pure) term loan, out of five insurance companies only one agreed to it without argument or aggresive ULIP selling.
I think the only reason people bought ULIP is because they can deduct entire ‘premium’ for tax deduction. The sad thing is people are under-insured as a result as only a fraction of the premium goes for “real insurance”, rest is actually an MF (no wonder the whole sebi vs irda power wars). I wonder why simple TERM insurance is not being sold more aggressively…its a need for everyone and Indians are seriously under-insured.
Reem – thanks for this – I am actually going to add this caveat in the points just now (and will credit you for bringing this to my attention)
You are welcome Alok.
I think LIC started the trend of this entire “money back” & “bonus” being attached to Life Insurance. My Dad bought a LIC policy for me when I was 5 years old in the hope that I’ll get a bonus when I grow up. That policy has still not expired and when it does (3 years from now) I will be getting a “bonus” of Rs.80,000. While that was a BIG number 35 years back, today it amounts to practically nothing.
Since all the private players are not sitting on the kind of cash that LIC sits on, they conveniently con the consumers to invest part of the insurance. That way even if the market tanks, they can wash their hands off and in either cases they’ll have pulled the consumer’s pants down.
When folks asked me to buy a LIC policy for my new born daughter, I told them I rather invest for her than take an insurance policy. When I explained the rationale, they stopped asking.
T K Rohit wrote a revealing article on 29th Jan 2009 about the state of Tax planning amongst IT folks. In that article he reveals that 82% of the folks did not have medical insurance cover and 13% had some insurance cover provided by their employers.
Let alone not being able to differentiate between insurance and investment, our educated, super-achiever folks don’t even care about insurance and hence are definitely under insured.
To know read the article in detail check out the link below… really perplexing. Hope these kind of blogs and articles help build some awareness.
http://www.righthorizons.com/TitleFiles/340Times-of-india–Pg-19-Date-29-1-2009.jpg
Alok you have written it nicely and you have addressed the real crux of the issue. Unfortunately, in the whole discussion that happens in public domain and mainline press on this topic which was triggered on account of the initiative taken by SEBI, this crucial point never gets covered. Naturally because most often the reporting is no objective but heavily influenced by the interest groups. Try to publish this in some news papers too.
I don’t know whom i’m addressing this, but please read my observations
Insurance is nothing but income replacement to the dependents if something happens to the bread winner.
Regular savings is an habit which you inculcate and you accumulate for rainy days or for a purpose identified.
combination of both is a process where you accumulate wealth or start saving for a purpose and the insurance is just to provide the proceeds to your dependents if death or disability prevents the individual to do.
if you live,Please accumulate and meet the need/Goal and if you are not there the insurance pays to your dependents the money which you intended to accumulate/save .
End of the day it’s your need ,your goal and your dependents
People who work in SEBI and IRDA are paid monthly
@Unni – My name is Alok Kejriwal and I own and operate Rodinhhod.com – thanks for ur comment that I have published.
My small comment on what u have said:
There is no confusing the importance of insurance. If the premium paid for ulip type plans were used for term insurance, the sum assured would rise manifold times.
Alternatively if the sum invested in ulips were invested in pure mutual funds, the sum earned would rise manifold.
My point is – invest in insurance for insurance sake – not as an investment to earn returns, coz if you do, you will lose a lot of potential returns – money!!!
And that loss is what sebi is tryin to minimise.
Alok [email protected]
Excellent timing since the month of March is time when agents raven upon the hapless souls. Folks should atleast use Search Engine’s and MS Excel atleast before jumping into bandwagon.
Alok, I have tried to help some of my friends understand the difference between insurance and investment but I guess you are a master describing it. So I will share this post with them. I hope my children too read this when they grow up
One other point I would like to make/ observe is the difference between pure term and whole life/ retirement insurance options. My understanding is that pure term insurance costs the least and the difference in premium between pure term and whole life etc., could be re-invested in MF or stocks for better long term returns while being in full control of the decision making process. Again many Indians don’t like to lose by paying for a term insurance scheme and surviving it! They say, if I live I don’t see a dime! Well, if they live thru it, they would have had that 20-30 yrs to multiply the difference in premium and that is assured to the family without going thru a insurance claims process. I hope that our schools/ colleges educate people to make economical/financially sound decisions rather than think like their parents (from the industrial age – pensions, PF, safety etc…).