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29/09/2017

Why Insurance Is Not A Good Investment

The insurance industry of India consists of 53 insurance companies of which 24 are in life insurance business and 29 are non-life insurers. Among the life insurers, Life Insurance Corporation (LIC) is the sole public sector company. Apart from that, among the non-life insurers there are six public sector insurers. In addition to these, there is sole national re-insurer, namely, General Insurance Corporation of India (GIC). Other stakeholders in Indian Insurance market include agents (individual and corporate), brokers, surveyors and third party administrators servicing health insurance claims

Insurance is becoming a key force in the Indian economy. Life insurance is evolving into a big challenger to banks and mutual funds in channelising financial savings. The insurance industry comes in three forms — reinsurance, life insurance and general insurance or property and casualty business. Many countries permit a single entity to do both life and non-life business

Insurance operates on two big needs. One, saving for a goal, where it is competing with any asset manager. Other is a tool to financial security. It is true in life, health, motor, travel or in business-related areas like marine, fire, business continuity insurance. It is a first step to financial risk management for everything. If the fundamental hypothesis is that the economy is on the growth trajectory, then it is quite logical that these will be driven by the growth of economy. The need for insurance is permanent in nature. It is not for a service need or for a product created for a limited time.

The common area represents traditional plans like Endowment, Money Back, etc. This is a problem area as insurance cover is poor and returns are also poor.

If a customer wants a pure investment proposition, insurance is not the product. Every insurance product comes with life cover. If a consumer does not value the life cover, he might want to buy a fixed deposit or a mutual fund product. The idea of a life insurance savings product is that a person will be able to meet their financial objectives whether dead or alive. From a general insurance perspective, the industry has been steeped in talking about savings elements. There is a history to it.

Mutual funds have seen investments in the last few months. The biggest driver for their success has been SIP. Arguably, insurance savings product is the original SIP. In the financial savings hierarchy, cash and deposits are about 60% of financial household savings, insurance is about 20% then mutual fund, shares, debentures at 6-7%. Clearly as an industry, which protects life, it has a reason to grow. People found mutual funds as an equity product. They have been able to position as asset allocators.

An ever-increasing number of people are ‘investing’ in insurance due to the higher amount of insurance advertising and marketing that they are exposed to. Over the years, we have been bombarded by insurance pitches at a rate that is far higher than earlier. This is a natural by-product of the competition in the insurance industry and by itself there is nothing wrong with this.

To be sure, there are many superficial similarities between insurance and investment, and this is what causes the confusion. Loosely speaking, both involve giving money to a financial service provider in exchange for a future benefit but there the similarity ends.

The purpose of insurance is to cover the financial aspect of risk. The risk can be of property, life, health, legal liability and of many other kinds. The only logical kind of life insurance that makes sense is term insurance because only in that case are you are insuring against a risk that is insurable

The problem with buying investment disguised as insurance is that there are many characteristics of insurance that are most undesirable in investments. Here are some major problems:

Illiquid: Investments should be liquid. The investment part of your insurance policy is locked in for enormous periods of time. The investment part of insurance offers moderate returns and decades-long lock-in.

Lack of transparency: Malpractices, inefficiency and poor performance in any kind of financial service are almost always rooted in lack of transparency. In this regard, the insurance industry in India just doesn’t measure up to the standards that are followed by the mutual fund industry.

Cost: Compared to what agents selling mutual funds, Reserve Bank of India and other bonds and Post Office deposits get, the commissions received by insurance agents are enormous, generally around 15 per cent of first year premiums and 7.5 per cent in the second and 5 per cent from the third year onwards.

Historically, insurance companies are more retail compared to mutual fund. MFs are focused on large cities, corporate distribution driven and their concentration is high. Insurance has been able to do better than mutual fund in asset build-up. In 2000, when the industry was opened up, LIC’s asset under management was same as UTI. Today, LIC’s AUM (Assets Under Management) is 15 times UTI’s AUM.

Over a shorter term, mutual fund is better. In 8-10 years, any unit-linked product will end up being better. LIC’s average premium is Rs 3,000 to Rs 5,000. Out of 10 people the agent meets, three will agree to buy. Smaller percentage of commission makes it unviable. Remuneration in insurance is based on premium, and in mutual fund it is on AUM. A distributor earns more as trail basis on AUM, than an agent earns on insurance. It is about tenure. A lot of MF business is done by institutional distrbutor. Insurance is a very different business. In a shorter term, insurance seems expensive and in the longer run, mutual fund seems expensive.

By Nishad MUKHERJI

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