Remove the weeds if you want a healthy insurance portfolio
Insurance is an area that cries for attention in people’s financial portfolios. As planners, we dread the prospect for the most part for there is a thicket of policies that needs to be gone through. We, as planners, generally examine these and validate the need for keeping these policies in the portfolio.
On an average, a client will have about a dozen policies. And usually, these will be endowment policies, moneyback policies, unit-linked insurance plans (Ulips), and occasionally, the term policy. It is ostensibly to take care of children’s education/marriage, retirement and so on. But many times, there is no logic as to why so many policies were taken.
Very few people have actually made the effort to find out whether the policy chosen is suitable for their requirement, what the policy benefits are, it’s costs and so on. What usually happens is that the distributor would have asked them to go for the policy and they purchased it for the amount of premium they felt comfortable with. Nothing was ever discussed about how much was really required for education or which vocation the child might choose. The only thing discussed was how much the client can spare for the premium.
Myth about traditional policies
The media onslaught on Ulips has had one positive and one negative after effect. The positive development is that due to the heat that was turned on Ulips, charges have come down drastically. The fallout, however, is that the perception now is, Ulips are very costly and unsuitable products. Even today, consumers and even those from the financial services industry believe that.
This has created an opportunity for buccaneers in the financial services industry to push traditional products, whose structures are opaque. Traditional insurance policies take as much as 100% of the first-year premium towards charges (which we can gather from the fact that the first-year premium is not taken while calculation of surrender charges). However, taking advantage of the flawed perception, distributors push traditional insurance policies.
Insurance is about providing security. Hence, a simple term insurance is an effective low-cost solution. How does one decide what to do with the forest of policies accumulated over time? Here is what one could do. First, you should check if the policies are still relevant. Policies with sum assured of something like Rs.1 lakh or Rs.2 lakh may not be relevant in current circumstances—the amount is simply too small to matter. It would be advisable to make these policies paid-up or better yet, surrender them.
The second check is whether the policy can even remotely meet the intended goal? In most cases, it will not be able to, as the policy was not given due consideration at the time of purchase.
The third check is if the insurance premium payments are affecting achievement of one’s goals. In many cases, they are. And in some cases, so much money has gone into insurance that all savings are through insurance alone. In such cases, surgery is in order. Many insurance policies that are directly affecting cash flows would need to be surrendered and others, which cannot be surrendered for some reason, can be made paid-up. With some types of policies, one may need to either partially withdraw or take loans to make things work.
The fourth check is to see how to simplify the portfolio itself. An unwieldy portfolio of, say, 15-18 policies, is difficult to manage, even if it does not suffocate the cash flows. At least there is no real problem here. It is a good idea to simply weed out the small, unwanted policies, even though one has to take a hit in the form of losing out on the money paid as premiums.
The fifth check is to see if the ongoing charges are high and if by keeping the policy, one will end up with a measly return. If true, then it’s a case for surrendering and investing elsewhere.
The sixth, and final, check is to find out if the policies give the basic yield that a debt product gives on a post-tax basis. For instance, if a traditional policy is offering 5.5-6% returns, it would roughly be equivalent to what one would get from a fixed deposit or post office investment, on a post-tax basis. If debt allocations are required in the whole portfolio, some of the insurance policies can be allowed to stay as part of overall debt allocation.
One needs to clearly understand that while surrendering, there will mostly be a loss on even the premiums paid. All due considerations outlined above have to be taken into account before arriving at a decision. Insurance portfolio has to be managed well. It grows like weeds because most people keep buying policies that they do not need. The problem is compounded when a friend or relative is selling the policy. The portfolio has to be pruned and maintained, much like a garden. Remember that insurance is for protection. If that is understood, one will never go wrong.
Suresh Sadagopan, founder, Ladder7 Financial Advisories.