Mr. Rao (31) recently walked into his bank to open an account for his 2-year-old daughter. During the account, opening formalities, he was suggested by the bank executive to buy a Children’s insurance policy which according to the executive could take care of his daughter’s educational funding requirement. After a session of Q & A, Mr. Rao promptly gave the go ahead for the insurance policy and purchased a Rs. 5 lakh sum assured insurance policy for an annual premium of Rs. 30000. Similarly, Mrs. Smita (34) was advised by her life insurance advisor to buy an insurance policy for her twin sons aged 1 year. Many a times insurance purchase is an emotional affair in India. The main bread earner may not be sufficiently insured but he would like to take a policy for his son/daughter as soon as he or she is born. No investment logic works in front of emotions. The belief that the insurance policy will enable a forced saving for the child/ children’s educational funding is partly true but is it the right investment for the child? To answer this question, we need to understand how the children’s insurance policies work.
Insurance policies are of two types viz- Traditional and Unit Linked. Traditional insurance policies are those insurance policies where the monies that you pay as premium are invested as per the regulations set by IRDA. These policies have to invest namely in Government bonds and approved securities of select Public sector institutions including social / infrastructure sector. These policies are non -transparent and announce an accrued bonus rate each year based on the performance of the company. They facilitate payment of a part of the sum assured at certain milestone age of the child for example, 20 – 25% of the sum assured will be payable when the child turns 18, 20 etc to facilitate the payment of higher education fees. At the current bonus levels the best annualised return calculated for the entire holding period ranges between 4.5 to 6%. Going ahead with falling interest rates, the bonus rates will fall further thereby further reducing the overall return. Of course, insurance advisors will argue that it also offers tax benefits and premium waiver in case the insured parent (proposer) dies in between, but then how many people today depend on the insurance premiums to complete their tax savings of paltry Rs. 1.50 lakhs per annum when there are better options available. The second type of insurance policies are unit linked polices which provide a range of investment options to choose from within the policy. For example, you could choose to invest in an equity fund which comprises of 100% shares or balanced funds where the equity allocation can be upto 65% and rest into government bonds and securities. These policies are more transparent in terms of disclosure. They provide a regular unit statement like mutual funds and one knows the status of the investment at any point of time. But unit linked plans do not provide any guaranteed amount at maturity as the risk is borne by the policy holder. Here one has the flexibility of changing funds regularly and there is a possibility of earning much more than traditional policies but one needs to keep a few things in mind while buying unit linked children’s plans.
1. The policy will charge towards insurance (mortality charges), fund management and administration which will reduce your overall return
2. Understand the risk-reward equation particularly if you are opting for equity oriented funds
3. Unit linked polices will work only if held for its complete term as the stock market is very volatile in the short term but performs better in the longer term.
The bread earner of the family needs insurance protection not the child as he is the income earner and his/her death might result in financial loss. So, ensure good level of insurance protection for self-first with the help of term insurance which is the cheapest form of insurance and to meet the investment needs of the child for his future educational expenses, start investing in systematic investment plans (SIP) in good balanced and equity funds. Remember to keep the investment period longer to coincide with the milestone years of the child to ensure better returns. To ensure tax benefits these SIPS can be done in Tax saving mutual funds known as ELSS funds (Equity linked savings scheme).
IF you aren’t a disciplined investor, then unit linked plans might be the best solution for your children’s goals as the contributions (Premiums) tend to get paid regularly and due to the emotional connect with children, people don’t touch these investments. Due to IRDA’s constant intervention nowadays most unit linked policies charges have reduced substantially. Take some time to understand the policies as once you complete the 15 days free look in period of the policy, you cannot do anything for 3 years in case of the traditional policy and 5 years in case of unit linked policies.