Every individual having insurable interest in his life needs an insurance coverage. The life insurance coverage is bought with an objective to provide financial cushion to the dependents of insured, in event of an unfortunate event of death of insured person. Life Insurance companies offer different kind of insurance products which are primarily divided into :
1) Pure risk coverage plan know as term insurance
2) Endowment plan and
3) Market Linked products known as Unit Linked Insurance Plan
Endowment plans have an element of investment into that which means endowment plans offer both risk coverage and return. Most of the investment made by endowment plans are in traditional financial instruments like government securities and high rated bonds. There is a very limited investment in equities. These plans are very popular in India. The reason for the popularity is that these plans have been pushed very effectively by insurance agents to a large set of traditional Indian investors who are more keen on fixed return and extremely risk averse.
Unit Linked Insurance products which became flavor of the season in the pre-2008 era are an insurance product with combined features of mutual funds and insurance. Most of the investment done by unit linked plans are in equity though they investors options to chose different investment options including debt instruments.
Whatever be the type of insurance product, they cannot be used as an investment product. The best use of insurance product is for risk coverage. There are more than one reason for not buying insurance product merely for risk coverage and these are:
1) Insurance companies offer returns which cannot beat inflation especially in case of endowment plans. Returns offered are as low as 2% to 5% which means that returns are not good enough to cover inflation in a country like India.
2) ULIPs have very high expense ratio. In some case ULIPs have expense as high as 30% in first year of the policy and may continue to higher in first few years of the policy.
3) Insurance companies pay bonus to the investors in endowment plans which are called as simple reversionary bonus which means that compounded return is not offered on bonus. This reduces the effective rate of return
4) Once your money gets blocked in an insurance product you cannot come of the investment without very high exit cost. This means that you are trapped for ever unlike investment into mutual funds, bank deposits, where exit cost is relatively very low.
So next time when you decide to buy an insurance product, don't get influenced by what your agent tells. It is better to evaluate the insurance product and then make investment. But remember insurance is not an investment product.
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