Why insurance is not an investment tool.
Though life insurance has a savings element, it is not an investment tool. Part of the premium that you pay goes to buy yourself some protection. For the initial 2 to 8 years a chunk your premium is used to cover the agent’s commission. As a result, only a small portion goes into the savings account.
Example: Whole life insurance.
You pay $300 premium monthly for whole life insurance for coverage of $200,000. Assume the agent takes $60 as commission, $150 for protection and $90 goes to savings.
You can emulate the package above by buying term life from the insurance company and invest the savings with an investment fund manager.
Example: Term life insurance + investment fund.
You buy term life insurance for coverage of $200,000. Assume the premium as $170. Assume the agent takes $25 as commission and $145 goes on to buy protection. Then you invest with an investment fund for $130. Assume then fund manager’s commission is $5. This leaves you with $125 going to your savings.
In both the examples above, you pay $300 and you get the same amount of insurance cover. However, you end up with more savings in Example 2.
The examples above were not meant to show that you should buy term life insurance and not whole life insurance. Rather it is to highlight that you should not treat insurance as an investment tool.
The advantages of separating your insurance from your savings are:
- Your investment grows faster.
- You can vary your monthly contribution to your investment fund. You usually cannot vary your monthly premium for your whole life insurance. So, if you had put your savings as part of the insurance premium, then you have to contribute a fixed amount every month.
- The potential of your investment in unlimited. Your investment fund can grow as high as possible. However, when you buy whole life, your investment growth is capped at the sum insured amount.
The disadvantages of separating your insurance from savings are:
- You are insured for a fixed term and not whole life.
- Your insurance premiums increases with age.