Recently, I got a call from one of the insurance agents,
giving me a plan which seemed out of the world. A little calculation proved how
these insurance agents mis-sell their products, and how the top minds from the
business schools do their best (and succeed) to sell these.
Below is the plan from the insurer (I would refrain from naming the insurer)
Plan A – Pay 60,000/- per annum for a policy with sum assured
of 15 Lakh for 20 years, and get a life time pension (yes, till the time you
die!!) of 60,000/- from 20th year onwards. Consider that the person
is a 30 Year old male.
This would seem too good to be true at the first sight, but devil
lies in the details.
Let’s consider the (only) two possibilities-:
- The person dies before the completion of the term, and insurer pays him the SA of 15 Lakh, and the policy is closed.
- The person pays all the premiums and insurer starts paying him the pension of 60000 per annum till the time he’s alive (Let’s assume the maximum age of 100 Years – So insurer pays him from 50 years age to 100 years age, i.e. for 50 years).
Excel provides a very powerful formula to calculate the
returns when you are investing and getting money back at regular intervals. –
IRR.
Below is the table that shows the IRR or – Rate of return
for the policy.
Now, type the formula as =IRR(B2:B100). (Or, select all
the values of amount paid).
The result you see will be 2.88%. That means, the overall
rate of return if you are alive till 100 years of age, will only be about 3%.
Age
|
Amount Paid (-ve)/ Received(+ve)
|
30
|
-60000
|
31
|
-60000
|
….
|
-60000
|
….
|
-60000
|
48
|
-60000
|
49
|
-60000
|
50
|
-60000
|
51
|
60000
|
52
|
60000
|
….
|
60000
|
….
|
60000
|
98
|
60000
|
99
|
60000
|
100
|
60000
|
Now, consider that the person goes via another route – that of
separating insurance and investment, and create a similar plan for him.
Here’s how it looks like.
Plan B:
- Term insurance for 50 Lakh with tenure of 30 Years. Premium for this person will be about 10000 per annum.
- Recurring deposit for 20 years in a nationalized bank (Safest option assuming 8% interest rates) for the rest of the amount – 50000 (approx. 4200 per month).
Now, again there are only two possibilities -:
- The person dies within the age of 30 years, he gets 50 Lakh (SA higher than LIC, and Cover period 10 years more than LIC), and has some amount in the RD option.
- The person completes the 20 years of recurring deposit.
If you see, the amount he gets back after 20 years of
recurring is – 28,02,295. (Source - http://www.allbankingsolutions.com/Recurring-Deposit-Calculator-India.shtml)
Now, a simple calculation would show, that interest income
on 28,02,295 assuming 8% interest (on PPF/ FD’s etc.) would yield about
2,24,180 per annum.
So the person can withdraw a pension of 1,00,000 (much
higher than the pension in plan A) and re-invest the remaining amount. This
would mean, he gets a pension for the rest of his life, and his investment
keeps on growing.
The above example assumed the safest options of investments
(RD, FD, PPF’s etc.). If the person has a long term horizon (e.g. 10+ years), then
a mixture of investment into Gold, Mutual Funds and Stocks etc. may fetch a return of
more than 15%.
A huge number of LIC plans which are sold, fall in similar
category, i.e. – A mixture of investment and insurance, which rather give a
very low return. A classic example is the money back policy-:
If you try to calculate the IRR for the above policy, it'll be about 7% (best case) and 3% (worst case) as per the numbers provided on the page, which again, I think is not a good option.
In my opinion, any sort of a which mixes investment and
insurance, can be broken down and a much better plan can be created using the
above example.
A question may arise, as to why people would go to LIC if it
were so bad? I can think of two reasons
- A lot of people do not go into details, and do all sorts of calculations. They tend to go with what the agents sell them.
- Traditionally, LIC was the only major player in this field, but now, with a lot of private players coming to market, I think the trend may change.
So, do you have a LIC plan? Or are you planning to buy one?
Or would you rather separate your insurance and investments? Do post your
comments/ questions.
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