Are guaranteed insurance investment products worth investing?
Recently, a Danish bank came up with negative interest rate home loans and made news all over the world. A negative interest rate implies that the bank will pay money for borrowing from it. Considering the current market situation, it is the right time that we reconsider our financial planning.
Why we should save?
First of all, it is important to know the reasons for and benefits of saving. Saving for the future provides protection against uncertainty, maintenance of the standard of living and reduces the risk of running out of money due to high old-age medical expenses and provides many other benefits. Many financial asset classes are available to save and invest. Understanding of the investment alternatives is a must to identify
appropriate assets suited to an individual investment needs. As life insurance penetration in India is one of the lowest around the world at around 3.5%, it seems many people are not educated about insurance. Thus, it becomes important to first understand the definition of insurance.
What is insurance?
In simple language, insurance is a product offered by an insurance company (shortly called the insurer) in exchange of a premium to indemnify the other contracting party in case of a loss. A guaranteed savings insurance product provides financial protection by offering insurance coverage both in case of death and survival of the life insured.
Assessing insurance as an investment
Many investment options are available in the market to meet the savings need such as equity, bank deposits, bonds, property and gold. Return is an important measure in evaluating the choice of investment. Expected return on secure investments vary from 6% – 9% and on risky investments range from 9% – 15%. On the other hand, return on most of the savings insurance products ranges from 4% –
Considering the higher return on other asset classes, it does not seem wise to invest in insurance products. But simply considering the return as investment choice criteria without considering other implications such as risk and flexibility will lead to an improper conclusion. All asset investments provide a return on the current investment only but the beauty of guaranteed return insurance savings products is that it provides guaranteed return on the future premiums (investment) also. This means the return on asset classes other than insurance is not certain for investment done in the future years. Hence, it becomes extremely important to understand the risk attached to the change in return potential over time.
Historical trends highlighting risk on other assets
Considering the historical return pattern on government bonds, interest rates in India have gone down drastically from around 12% in 1999 to 5% in 2004 and 8% to 6.5% over the last one year. Even in the international market, drastic changes in interest rates were observed historically. In the United Kingdom, interest rates fell from around 8% in 1996 to 4.5% in 1999 and 1.5% to 0.5% over the previous year. Similar interest rate movements were observed in Japan where the interest rates fell from 8% in 1990 to 3% in 1993. Interest rates have even become negative in some of the world economies such as Denmark, Japan, and Sweden.
Why invest in insurance?
History is a fair indicator of the future possibility for changes in the financial markets. The high volatility in interest rate risk represents the risk of poor investment return on future investment. Insurance savings products protect against this risk and offer a guaranteed return even for the future premiums for as long as 20 – 30 years. Investment in insurance products provides diversification from traditional investment instruments. Insurance products also provide a good match for future liabilities by offering flexible products with features such as income benefit and endowment benefit (benefit at the end of the policy term). These products allow matching future outgoes such as child’s education and marriage and hence reduce liquidity and reinvestment risk.
How much to invest in insurance?
Now as insurance products seem to be an attractive investment choice, the question arises whether 100% investment should be done in insurance? The obvious answer is no. Insurance products provide guaranteed returns but offer lower returns compared to other asset classes. The choice depends on the risk-return trade-off. The proportion of ideal investment in insurance depends on the risk preference of
the individual and certainty of income (as discontinuity charges are high in insurance). It is important to ask yourself these questions yourself: Have you planned your retirement needs fairly? Have you invested in insurance? Since the investment in insurance is a long-term financial commitment, it is advisable to consult financial experts and understand the product fairly to ensure customer needs are met.
The author of this article is CA Shirish Jagnani. If you have any queries concerning the above article. Please write to us either in the comments section below or email the author on shirishjagnani89@gmail.
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