The headline for this blog is very stark and convulsive. at the outset I apologise for the same. I would however persist with the headline for very fundamentally true reasons. It brings about my experiences of discussing financial products with various "new age" financial services companies (primarily insurance companies).
India is witnessing a big upsurge in financial services domain - specifically insurance. Many companies are offering a range of insurance solutions for mitigating / managing various risk that we carry as individuals. Such upsurge demands increased hiring of insurance advisors / sellers / consultants. Banks also take upon themselves to peddle these products to their customers as value add. I am going to focus in this blog largely on one of the insurance offering - Life insurance.
Fundamentally the concept of life insurance is based on sound grounds - If the key economic earner of a family dies, the dependants are protected from financial vagaries through life insurance benefits. So ideally the insured person targets an amount which in his / her absence on account of death would take care of his dependants until they can find their own footing. The key parameters for life insurance products are:
a. the insured person is a key economic provider to his / her dependants
b. death of the insured person would result in insurmountable financial difficulties to the Dependants, and
c. the payout from insurance company would address the financial difficulties of the dependant and facilitate maintenance of the economic lifestyle despite demise of the key economic provider.
A variation of this life insurance product is that if the insured person survives the term of insurance then he would get a lumpsum amount or annuity payments (called pension). However for these variation of product the premiums payable are also substantially higher.
Insurance premium Mathematically -
i. base product premium is "x" which would result into benefit to dependant / nominee in the event of death of insurer.
ii. the variation premium resulting into lumpsum / annuity payment "y". This Y is nothing but the amount that will aggregate at a given interest rate into the lumpsum payment in future.
iii. total premium = x + y
Insuring whom and what:
In the zest for business growth, insurance companies have started offering "insurance product" on children too. I have personally received pitch for life insurance product on my child. The insurance agent was soliciting me to pay life insurance premium (X + Y in the equation above) on behalf of my teenage children. I asked the question as to why should a parent pay insurance premium for their child. I would again request readers to read the para 3 above to understand the depth of this question. The response I got from agent and my views are captured below:
Agent Response no. 1: It is a good practice to take insurance. we would teach our child about personal finance management. My view: Savings and financial prudence is a good practice. We need to teach our child surely about these aspects. Insurance is an aspect of financial prudence which has a specific use (again request refer para 3 above). It needs to be kept in mind that the "X" (premium) is actually not saving. its only cost of financial prudence of managing a risk. Thus by insuring a parent is not teaching savings to a child.
Agent Response no. 2: Starting insurance early will keep the cost of insurance low for the child. My View: There is a fundamental truth in this statement that "earlier insurance starts lower the premium (X) for same coverage". There is however an important rider that one needs to keep in mind - how does a parent decide what level of coverage does a child (technically child dependant) require. My parent might have felt a INR 5 lakh coverage was substantial when I was a child. When one examines that coverage today it seems insignificant. If I enhance the coverage to a higher number, the applicable premiums would not be substantially lower because of my history. The corollary also is important to note, lets say I take an insurance cover of INR 4 crore on my child (because I love them so much). as they grow up their independent economic means might not be sufficient for various reasons to pay this premium. This would result in my continued payment of premiums on behalf of my child for his / her dependant. Philosophically and commercially these thought does not add up or appeal.
Agent Response no. 3: It is a good savings option and also offers tax benefit. My View: The mathematical equation above clarifies that premium "X" is not saving. The "Y" component is saving. This "X + Y" can be invested into a long term government bond with better returns as the insurance product offers. The tax benefit aspect I will expand a bit now. The argument in favour of insurance product is that if and when the amounts are received from insurance company, they would be tax free. Amounts that can be received from insurance company can be of two kinds:
1. death benefit to dependants: discussion of tax benefits on amount received on death of a child seems emotionally and commercially insignificant. As parents, we wouldn't want to benefit from child death. and even in the worse case eventuality, tax on any sums received on such unfortunate event would be from parents point of view not financially important.
2. payout as pension or lumpsum amount on completion of the term: such pension or lumpsum amount would be projected beyond atleast 25 / 30 years from the date of insurance inception. we have in the last 25 years seen a substantive change in the tax rates (reduction) as well as tax slabs (increase). the net savings on tax assuming marginal change in tax legislations according to my calculations are insignificant.
In Summary, Insurance on child's life is not a great way of saving, investing or teaching a child financial management. It is actually an indicator of how consumerist and numb we have grown. It also demonstrates how limited is our capability to understand basic personal finance despite being "educated". In the above set of observations / views, I have not touched upon the issues of Solvency / "bonus credit" practices of Insurance companies. That I am leaving for another time.
I would be keen to listen / get feedback from my readers on their own experiences wrt Life Insurance and its use.
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