Did you "BUY" Life Insurance OR was it "SOLD" to you?
You would wonder what is the difference being buying Life Insurance of being sold Life Insurance! The difference lies in the way value is perceived and value is realised.
What is the difference between buying a product/service and being Sold product/service?
The difference is the value perception and way value is realised. When you “BUY’ you are making a conscious and calculated choice based on the value you perceive of the product/service and the price you pay for it. When you are “SOLD” a product or service, you as a customer is told of the “Value” that you derive and you make a choice based on recommendation of a 3rd party and hence the choice may or may not be delivering the value perception created in you by a 3rd party. However, In many purchases, we rely on someone else recommending and then we make the choice, so why is this difference being questioned? And that too for Life Insurance Policy?
We will discuss this with 2 different but interrelated perspectives -
The product choices made by customers in Life Insurance and
The channel of purchase of Life Insurance
Life Insurance Products
Investment (ULIP) and Savings plans are the highest sales at over 80%, whereas the lowest sales is Protection (Pure term) plans at 5%. Pure protection is the “core” Life Insurance product and is the least bought. Incidentally it is also the cheapest insurance!. The fastest growing segment is also the largest, ULIP. The table below has details of two of largest Life Insurance companies. The overall Industry data is similar.
A. ULIP
A ULIP, is a life insurance plan that combines life insurance coverage with investment options (Or is it opposite Investment with small associated life insurance cover). The life Insurance cover in ULIP is small and bulk of the premiums paid go towards investing, hence making it direct competitor to Mutual Fund schemes. The key differences between ULIP and mutual funds as direct “like for like” comparison:
Liquidity
The linked insurance product do not offer any liquidity during the first five years of the contract. The policy holder will not be able to surrender/withdraw the monies invested in linked insurance products completely or partially till the end of the fifth year (This disclaimer is mentioned on the front page of the brochure prominently).
In contrast Mutual funds offer liquidity from Day one and charge a small exit load in case of withdrawal from the scheme before typically 1 year.
Fees/Charges:
ULIP (Charges shown are indicative from a ULIP policy of a major Life Insurance company as representative) (charges deducted before investing)
Premium allocation charges - 12% in year 1, 6% in year 3, 4% in year 3, 2% in year 4. Total of 20% charges deducted from the investible amount. (IRDAI permits annual charges of upto 12.5%)
In addition fund management charges between 0.65% to 1.35% per annum depending upon type of investment.
Policy Administration charges of upto 0.41% per annum
In contrast, in case of MFs, the total expense ratio (charges) varies from 0.2% to 2% depending upon the type of investments and channel of purchase
So, If the fund performance is similar in both ULIP and MF, your investments in ULIP will earn much less (20% or more lower as the funds invested are reduced by 20% due to the charges) as compared to the similar investment in MFs
Life Insurance coverage: In ULIP, the sum assured is very small compared to the need of the individual. E.g. if you have an annual premium payment of Rs 2.5 lacs for 10 years, the insurance coverage is 12.5 lacs to 25 lacs only, whereas an average protection policy sold today has coverage of Rs 50 lacs or more (see our earlier article)
Tax treatment
ULIP
Scenario 1 - If you have paid annual premium less than 2.5 lakh in all the years during the tenure of the ULIP, the maturity amount is tax free
Scenario 2 - If you have paid annual premium exceeding Rs 2.5 lakh, the amount received at the time of maturity will be taxable as long term capital gains
Equity Mutual Funds if held for more than 12 months are taxable at long term capital gains on Exit
In the first scenario, given that the ULIP amount invested is lower due to “charges”, Mutual Funds even without the tax exemption, provide better post tax returns! with same fund performance
In the second scenario, both ULIPs and MFs have same tax treatment, hence no advantage to ULIPs and MFs deliver superior overall returns compared to ULIP
So, which product has better “Total Value” for a policy holder - ULIP or Mutual Funds + protection policy?
B. Savings products - A typical savings/retirement product of Life Insurance company provides long term pre-tax returns of around 6-6.5%, In contrast Debt Mutual Funds or Bank FDs provide around 7% or more for longer tenure(HDFC Bank was till recently offering 7.25% quarterly compounded FD for 10 years). Even at lowest repo rates in 2021, FD rates for 5 to 10 years were offered at around 6.5% to 6.8%. So, there alternates to Life Insurance savings products are slightly better in terms of benefits
Channel of purchase
Online direct sales of Life Insurance started in India in 2011-12. In the 13 years, while the Industry has grown by leaps and bounds, the online purchase of Life Insurance has remained at very low levels. It was 0.96% in 23-24 and for 9 months of 24-25 it is similar
ACKO and GODIGIT which are pure play online Insurance companies, together had total premiums of Rs 38 crore in 24-25 compared to Rs 1,50,000 crore by all private life insurance companies
Bulk of the sales of Life Insurance is by Banks
Why should channel of purchase make a difference in Life Insurance?
Life Insurance companies are allowed to pay high commission to Agents
The high commissions translate into higher premiums to customers (higher price for the product), if sold by an intermediary
If a customer buys directly through online channel (Any life Insurance product) without the help of an intermediary, it pays significantly lower premium for exactly the same benefits
In ULIP the high premium allocation charge that we discussed earlier are due to the commission paid to intermediary which reduces the amount invested and hence lower returns
The highest commission of upto 40% is paid on protection policies, but that is the least selling product (Because it is difficult to sell!)
In contrast, buying a mutual fund through intermediary results in ongoing additional annual costs of only 1-1.5% as compared to direct purchase
What does all the above convey?
The highest sold Life Insurance policies are the ones which have significantly lower total benefits compared to “Like for Like” substitutes
Buying direct online is the cheapest, but it contributes to < 1% of sales
The best value provided is to buy “combination of pure protection life insurance+ mutual fund” and through online direct buying
So, Did you "BUY" Life Insurance OR was it "SOLD" to you?
We do hope you have enjoyed reading this issue of The Chai and Charts Chronicles. If you like it, please share the same with your friends and colleagues and if you have not liked it, please share the feedback with the author at menghrajani1@gmail.com
In case you have missed any of our earlier posts, you can read them by clicking here.
Agree with the views expressed by the author. I have never invested in ULIP mainly because of the very high charges. However, I know that many investors have fallen for it w.o properly knowing the pros and cons!