Taking insurance to save tax? Think again

Budget 2008, Run up to budget

Mumbai: It is that time of the year when people suddenly wake up to the fact that they need to make tax-saving investments. And what they are most likely to do is buy insurance either from the neighbourhood bank or the friendly insurance agent.

One should, however, keep the following things in mind before doing that.

a) Insurance for insurance sake: The Compact Oxford Reference Dictionary defines the word insure as “arrange for compensation in the event of damage to or loss of (property, life or person), in exchange for regular payments to a company.” The regular payment made to the insurance company is referred to as the insurance premium.

In India, a majority of the premium paid is invested in line with the risk the policyholder is willing to take, from 100 per cent equity to 100 per cent debt to various combinations in between. A small portion of the premium paid also goes towards actual insurance. Do remember this, when you are buying an insurance policy. Chances are you will be underinsured and your nominees will not have adequate protection if something were to happen to you.

b) Horses for courses: Do you hire your barber as your dentist? Obviously not. When you need to get your haircut you go to a barber and when your teeth are giving you a problem, you go to your dentist. It’s as simple as that. So, why go to an insurance company to get your investment managed? It is a well known fact that the best fund managers and investment professionals do not work for insurance companies. Hence, go to the better performing mutual funds to manage your investment and buy pure insurance policies, or term insurance, from insurance companies. This way, you will be properly insured and also ensure decent returns from your investment.

c) Mutual funds aren’t for the short-term: Most unit linked insurance plans (Ulips) have given lesser returns than the Sensex in the few years that they have been in existence. Most insurance companies explain this by saying, “Mutual funds are short-term investment products and Ulips are long-term investment products.” Now, what have mutual funds got to do with the underperformance of Ulips? This is just a bogey to justify the underperformance of their products. If the fund managers of insurance companies cannot deliver in a bull market like this (the current correction not withstanding), can they ever deliver? One who doesn’t know how to dance, blames the floor, or so goes a popular saying in Hindi.

The reason Ulips are popular is that insurance agents sell them aggressively. Ironically, the Ulip sales pitch makes it out to be a short-term product. This is because the distributors/ agents get to earn very high commissions in the first two years of the policy, so, it makes sense for them to sell a new policy to the individual after three years.

None of this, however, makes mutual funds any more short term products than Ulips are. In fact, experts always advise mutual fund investors to stay invested for long durations and benefit from the power of compounding.

d) With insurance you are stuck: Most Ulips have very high expense structure in the first few years. This is used to pay the high commissions to insurance agents. Insurance companies blame this on the Insurance Act, 1938, which allows commissions of a maximum of 40 per cent of the premium paid. That’s the most weird rationale you will ever hear - that you go around paying hefty commissions just because the law caps the commission amount at a certain level. Sadly for investors, bigger commissions to the agents means lesser amounts invested.

Predictably, the high upfront commission structure dents the investor’s corpus significantly in the first three years. Yet, when one realises after three years that the Ulip is not performing well and wants to get out, he has to pay a surrender charge. Given that much of the premium paid so far has gone into paying commissions, he would be really lucky to recover the premium paid till that point, forget any return on that amount. The next best thing to do is to carry on paying premium and hoping the Ulip will perform someday. If you are investing in a tax-saving mutual fund, and you know that a particular scheme you invest in hasn’t really been performing well, you can easily start investing in some other scheme. Ulips don’t give you that flexibility.

e) Don’t go by the ads you come across: Most insurance advertisements show a happy family, which owes its happiness to the fact that it had bought insurance from that company. By now, it shouldn’t be surprising that most of these ads are for Ulips, stressing the investment aspect. But, if insurance is indeed the same as investment, the first thing you need to ask is how much return the Ulip has given? An answer would be difficult to get - it would be unusual to find an insurance ad that talks about returns.

So what have you? Surely, a good advertisement alone can’t make a good investment product? Also, try finding out the best performing Ulip in the market. Different insurance companies have different expense structures, hence their returns remain incomparable. That being the case, why settle for a product where you can’t even figure which is the best deal available?

Moral of the story – buy a term insurance policy, which gives you and your family an adequate insurance cover, and invest in tax-saving mutual funds, which have performed well over a period of three to five years.

Under license from www.3dsyndication.com

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