3X Returns From Life Insurance In 20 Years. Is It Good?

Insurance related SMS marketing campaign could be misleading. For instance, there’s an SMS doing the rounds these days about a policy that will “triple your investment in 20 years’ time”. Prima facie, this might seem like a fantastic opportunity. However, does it pass the ‘dig a little deeper’ test? Let’s find out.

This is an Insurance Plan

First and foremost, bear in mind that this is an insurance plan and not really an investment plan per se. Since it talks about ‘tripling’ a lump sum investment over a period of time, the policy in question is most likely one of the many single premium insurance plans that do not require making regular payments after the first instalment. Here’s a thumb rule – if an insurance plan promises you fantastic sounding returns, approach it with a fair degree of caution and evaluate it properly.

The wrong math

Upon receiving this SMS, chances are you’ll end up doing the “wrong math” and thereby miscalculate the true efficacy of this single-premium policy. The “wrong math” is to divide the absolute returns promised by the number of years – that is, divide 200% by 20 years to arrive at an ‘annual’ return of 10% per annum (which really is a very good low-risk, post-tax return)

The right math

The right math is to calculate the “compounded annual” rate of growth or CAGR on the investment. Put simply, it’s the annual rate of return on this investment, assuming that the annual profits earned get ploughed back into investment at the end of every period. The formula for compounded annualized growth rate gives us a much less impressive figure of 5.64% per annum. That’s the real number. 

Clearly, this is a return that’s much lower than what even low risk instruments such as bonds or fixed income mutual funds can provide. The issue is exacerbated further when you consider that the time frame in question is very large, and therefore makes it worthwhile to take on some additional risks by allocating at least a portion of the moneys to higher growth assets such as equities. 

The final verdict: go or no go?

There’s another critical factor to consider while deciding whether this policy is worth considering, which is - what’s the death benefit that you receive from this policy? Single premium plans tend to lump together an insignificant quantum of death benefit with returns that aren’t likely to be great. Can you achieve the same quantum of death benefit by simply purchasing a pure term plan with a small annual premium instead? You’ll probably fare a lot better by following doing that, and by diverting the lump sum into a balanced portfolio that can earn you 12% returns per annum for 20 years instead. Any guesses on how much Rs. 1 lakh will grow to, over a 20-year period at 12% per annum? Rs. 9.64 lakhs – and that’s a lot better than tripling your investment!