Our Funds
Related Links
Tools View All
Knowledge Hub Explore
Investment Frameworks
Insights View All
Obsessed with helping you invest better. Trusted by 50L+ investors*
Services
If you are a first-time investor or new to DSP, Get started here
New to IFAXpress? Sign up
Uh-oh! No results found. We're on it!
Listening ...
This will help us to improve and provide you a better experience.
Is insurance a type of investment? Know the drawbacks of Insurance cum Investment Products
An investor education & awareness initiative.
Most of us would have come across relationship managers who urge us to purchase an “attractive” insurance policy which has an “in-built” element of investment. The pitch for such hybrid products – which are commonly known as Unit Linked Insurance Plans (ULIPs) or Endowment Plans – is often presented on two occasions – when you seek a life insurance cover or when you want to invest surplus funds. On the face of it, such hybrid policies seem like a good option as they claim to help you achieve two goals together. However, is there something more than what meets the eye?
Insurance and investment – a tangled bundle
Like investments, life insurance is an essential element of a financial plan. This lone similarity is perhaps the reason why some people think that the products can be bundled together – irrespective of their unrelated objectives. As an investor or as a policyholder, you need to remember that the purpose of a life insurance policy is to protect you against financial risk in case of loss, whereas investments are made with the intention to earn reasonable returns, which are at least equal to the prevailing rate of inflation. Any product which claims to serve both of these purposes should be examined in terms of its additional cost, incremental risks and the extent to which the extra benefits are delivered.
What you give versus what you get
Insurance-cum-investment products offer both – life cover and return on investment. While the benefit of life cover is only available after the demise or disability of the insured, the investment returns can be realized during the course of the policy. However, this extra feature comes with an added cost and potential buyers need to evaluate if the additional cost justifies the stated benefit.
A closer look at insurance-cum-investment products reveals that most of them compromise on returns, which thereby raises questions over their suitability as an investment product. Moreover, these policies are fraught with several other issues which make them unsuitable as an investment option.
Major drawbacks of insurance-cum-investment products
Modest returns; high costs: The returns earned on insurance-cum-investment plans are – at best – modest. For example, endowment plans offer returns in the form of sum assured (fixed amount) and bonus (4-6 percent of the sum insured). However, the bonus and the sum assured are only payable at the time of maturity – which implies that policyholders incur significant loss in terms of the time value of money. The effective rate of return on such plans works out to be a mere 5-6 percent, which is significantly lower than even the returns offered by traditional investment products (such as fixed deposits and post office schemes).
In case of ULIPs, the returns depend on whether the ULIP is a debt-oriented one or an equity-oriented one; however, whatever the ULIP type, the returns are marred by high administrative charges. ULIP administrative charges mainly comprise of:
Premium allocation charge: This charge is levied to recover the costs of policy issuance such as the distributor fee and cost of underwriting. After the charges are deducted, the balance amount is used to purchase units of the funds selected by the insured. The policy allocation charges although capped by the Insurance and Regulatory Development Authority (IRDA) continue to remain high during the first 5 years of the policy.
Policy administration charge: The insurance company also charges the insured for regular expenses incurred for the policy such as premium intimation, paperwork, etc.
Fund management charge: The fund management charge is levied to manage the investment fund of the ULIP; it is levied as a percentage of the value of assets held. This is calculated before the net asset value or NAV is arrived at. The IRDA has currently capped the fund management charge at a maximum of 1.35 per cent per annum.
Mortality charges: The insurance company makes certain assumptions on how long the insured will live based on gender, health conditions and age; if the insured does not survive till the expected survival age, the company has to bear a loss (since it has to pay the claim). In order to safeguard against that, insurance companies usually levy a mortality charge. This charge varies from person to person depending on varying factors mentioned above.
◦Surrender charge: In case of premature selling of units by the insured, whether partially or fully, a surrender charge is levied. This charge is calculated as a percentage of the fund value or is taken as a percentage from the total annual premium payable. According to the current IRDA guidelines, surrender charges cannot be more than 50 basis points (0.5 per cent) per annum on the unit fund value.
In addition to the above charges, commissions earned by the agent on ULIPs are 15 percent in the first year, 7.5 percent in the second year and 5 percent from the third year onwards (for policies purchased offline). The premium allocation charges, applicable throughout the term of the policy, constitute 4-5 percent of the premium amount. On the other hand, mutual funds, which have a similar investment style, are quite cost-efficient as the expense ratio is capped at 2.5 percent (for equity mutual funds) and 2.25 percent (for debt funds). In their eagerness to pitch insurance-cum-investment plans, agents or relationship managers may not highlight the obvious drawbacks of these products. Policyholders may not be able to take informed decisions in case they are unaware of the heavy charges and commissions laden in such plans.
Liquidity issues: Ideally, investments should be liquid. In other words, investors should be able to convert their holding into cash at a short notice. However, that is not the case with investment in bundled policies. In case of ULIPs, there is a lock-in period of five years, whereas in case of endowment plans, the returns can only be availed at the time of maturity – which may be after 10-25 years. Therefore, insurance-cum-investment plans do not even offer adequate liquidity in comparison to traditional investment products.
Avoid the trap
Despite the many drawbacks of bundled policies, several people opt for the same. The “all-in-one” promise is perhaps the reason why they fall into the trap. To avoid the same, it is important to unbundle the products. The insurance component of the bundled policies should be compared with traditional term plans, whereas the investment component should be compared with pure investment products such as fixed deposits, equity mutual funds or debt funds. The comparison should factor in the costs, returns and liquidity aspects. On most of these counts, for most investors, a pure term plan and a separate, conventional investment product would score much better than any bundled policies.
Remember, in the quest for all-in-one, don’t end up with something that isn’t the best for any one.
Key Takeaways
Disclaimer: All Mutual Fund investors have to go through a one-time KYC (Know Your Customer) process. Investors should deal only with Registered Mutual Funds (‘RMF’). For more info on KYC, RMF & procedure to lodge/redress complaints, visit dspim.com/IEID. This is an investor education & awareness initiative by DSP Mutual Fund.
Sign up for our newsletters.
Investor Relations Officer, DSP Asset Managers Private Limited, Natraj, Office Premises No.302,3rd Floor, M V Road Junction. W. E. Highway, Andheri(East), Mumbai-400069, Tel.:022-67178000.
Mutual fund investments are subject to market risks, read all scheme related documents carefully. © DSPAM 2024.
Any information regarding securities offerings, or references to securities offerings, that are contained on these pages do not constitute or form part of any offer of securities for sale or the solicitation of an offer to purchase securities in the United States or in any other jurisdiction where such offer may be restricted. The information in the coming pages is not intended for, and is not to be made available to, persons in the United States (being persons resident in the US, corporations, partnerships or other entities created or organized in or under the laws of the US or any person falling within the definition of the term "US Person" under the US Securities Act of 1933, as amended), wherever located. Any information regarding securities offerings, or references to securities offerings, that are contained on these pages do not constitute or form part of any offer of securities for sale or the solicitation of an offer to purchase securities in the United States or in any other jurisdiction where such offer may be restricted. In no event shall DSP Mutual Fund and / or its affiliates or any of their directors, officers and employees be liable for any special direct, indirect, special, incidental or consequential damages arising out of the use of information / opinion herein. The site, texts, images, designs, pictures, sounds, photographs, animation, and videos together with their layout and more generally all the items contained on this website are the sole property of DSP Asset Managers Pvt. Ltd. This site and all of the elements on this site are protected by Indian Law and by International copyright agreements concerning intellectual property. The content of this website must not be copied, modified, reproduced, distributed, transferred, edited or made accessible to third parties for any purposes whatsoever without obtaining prior permission from the owners of this website. *No. of unique investors who had invested with DSP at any time. ^Includes domestic AUM only, as on Dec 31, 2023 @ copyright DSPAM All rights reserved.
By submitting, I agree to receive a call from DSPAM for assistance.
We have received your query and will get back to you shortly.
Gain access to our latest articles on the world of investments.
Monthly update on all the information related to our funds.
Monthly insights on the economy and markets.
To help you our services, we would be grateful if yo could tell us why:
Mention reason
Describe reason
Update your preferences
The email address [email protected] has been removed from our mailing list. you will no longer hear from us.