Child plans are no different from other endowment and money back policies except for their names. After deducting agent commissions and administrative charges, the premiums invested in safe debt options offer sub-optimal returns, about 6-7 per cent.
Insurance advertisements use the emotional appeal to connect to buyers. In the case of child policies, if you have watched the ads, you would see a child aiming to become a doctor or donning a graduation hat. Child policies are primarily pitched to parents as a saving vehicle for kids. Parents perceive these products having specific features which would help the child in their college years. Regular pay outs at key milestones in a child’s life and premium waiver benefits are the points an agent emphasizes on during the sales pitch of child plans. Parents would have to pay an amount X for limited number of years and then they would start receiving X+Y during the last 5 years of the policy. What this X+Y culminates in terms of percentage returns over 10-15 years is something they do not bother to ask the agent.
The fact of the matter is that child plans are no different from other endowment and money back policies except for their names. The basic design of any investment cum insurance product is to invest the premium in debt options, provide life cover and offer regular pay outs or a lumpsum pay out at maturity. After deducting agent commissions and administrative charges, the premiums invested in safe debt options offer sub-optimal returns, about 6-7 per cent. Even in the case of child ULIPs, which is an insurance cum investment product, the costs are too high (including mortality charges, administrative costs, agent commission, entry load, etc.) to offer decent returns. Further, there is no flexibility to get out of ULIPs, i.e., one can be stuck with a bad product in case the fund manager is not performing well.
Mixing insurance and investments is one common mistake parents typically make in their efforts to secure the financial future of their child. In fact, some fear the money if invested elsewhere might get redeemed due to lack of financial discipline. So, they consider insurance plans as an ideal option of regular saving and to lock-in the money until the child enters college.
But, the basic objective of life insurance which is income replacement of the earning member of a family is lost. A child usually does not earn money or support parents in his young age. So, he does not require life insurance, as simple as that.
Instead of spending on hefty insurance premiums, the money can be directed towards other lucrative options to save for a child’s education goal. One can start a systematic investment plan in an equity mutual fund and invest in a disciplined manner. The sooner one starts, the more time investments get to compound in value.
Consider a comparison between a child insurance plan and an equity mutual fund. For the child plan, the numbers have been taken from an insurance company’s brochure. The structure is akin to an endowment policy with tenure of 18 years and premium paying term of 15 years. The sum assured is Rs.5 lakh and the premium calculated comes to Rs.32,700. The cumulative pay outs are projected at a total of Rs.7 lakh at the end of the policy tenure. This translates into an internal rate of return of about 5 per cent per annum. Now let us assume that the premium amount divided by 12 (32700/12=2725) is invested in a systematic investment plan of an equity fund every month for 18 years. Assuming a compounded rate of return at 12 per cent per annum, the corpus would grow to Rs.21 lakh in 18 years. Even a decent 10 per cent return is assumed, the corpus would grow to Rs.16.5 lakh, more than double the cumulative pay out in the child plan.
Equities are thus a better option than child plans and the only asset class which can beat inflation. Education costs are rising by about 10 per cent per annum, every year. Parents today are spending lakh of rupees at the primary schooling level for their kids, even more than the higher education costs of the earlier generation. Returns offered by child insurance plans cannot match up to the rising inflation and is likely to create a shortfall in the education corpus. It is thus prudent to avoid these plans which do not serve any real purpose.
In order to build a decent corpus for a child’s future, the right approach parents must adopt is to first buy adequate life insurance on a need basis. It should be bought for family members who earn and have financial dependants on them. Then invest the balance amount in a decent equity mutual fund through a systematic investment plan for the long term, at least 5 years. To keep things simple, parents can earmark the investment for the child’s education goal and ensure the discipline of taking it out only when required at the actual hour of paying for college. These steps in the right direction would suffice to secure a child’s financial future.
Yogin is a member of The Financial Planners’ Guild , India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.
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First Published on Jan 4, 2017 05:29 pm