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Is insurance an investment?
There are many unanswered questions about insurance, and when you are just getting started with understanding the insurance market, you may find yourself facing many such doubts and queries. One such question that often bothers many individuals just getting started on their financial journey is this - Is insurance an investment?
The answer to this question is not a simple yes or a no. Given the many insurance benefits that are available today, it is more of a gray area that requires some detailed analysis and understanding. So, let us delve into the particular aspects of insurance and investments, understand what they each mean, and look at both sides of the case to figure out if insurance is really an investment. Or not.
What is insurance?
Insurance, as you have seen in the previous chapters, is a legal contract between an insurance provider and an insured person, where the former offers financial protection to the latter in case any of the insured events or contingencies occur during a specified period. In return for this financial security, the insured person needs to pay a certain amount of premium to the insurance provider.
In most cases, the financial payouts due under an insurance plan are specified at the time of purchase itself. Also, the payouts are only made if the insured incidents or contingencies come to pass. In case they do not happen, the insurance provider typically need not make any payouts to the insured person.
What is an investment?
An investment, on the other hand, is an asset or a scheme that you put your money in, with the aim of generating some periodic income or profits over the long term. Some investments increase in value over time, making it possible for you to enjoy the advantage of capital appreciation. Other investments, such as fixed deposits, recurring deposits, fixed income instruments and many government-backed investment schemes, offer returns at a predetermined rate.
So, in the case of some investments, you know the rate of return at the time of making the investment itself. In other cases, the rate of return is not fixed or predetermined, and it depends on the movement of the concerned market, like the stock market, the gold market or the real estate market.
Insurance vs investments: Summing up the differences
Looking at the details of insurance and investing discussed above, it becomes evident that insurance and investments work on very different core principles. In the case of insurance, it is essentially the principle of risk sharing that is of primary importance. The premiums collected from different policyholders form a common pool of funds that can then be used to pay for the financial contingencies covered.
Investments work differently. The primary objective of investing is capital appreciation. As the value of the asset grows with time, so does the value of the capital you invested in the asset. Some investments give you the advantage of income benefits instead. So, let’s sum up the key differences between insurance and investments.
Insurance runs on the principle of risk sharing.
Investments run on the principle of capital appreciation.
The payouts under insurance policies are typically predetermined at the time of purchase.
The amount of returns on investments are not always fixed.
The payouts under an insurance plan are generally only made in case the insured incident occurs.
Investments can be redeemed to enjoy the benefits of capital appreciation at any time (except in case there is a lock-in period).
Reasons why most insurance plans are not investments
As you can see from the table of differences above, insurance and investments have some jarring differences between them. And here are some reasons why most insurance plans are not investments.
There is no element of profits or gains in insurance
Most insurance plans do not offer any kind of profit or gains on the payouts made. The financial benefits are strictly to help the insured person tide over the unexpected financial crisis associated with the contingency that has been insured. So, for instance, if you have a car insurance plan and you raise a claim following an accident, the payouts will be just enough to cover the cost of repairs or damages, and will have no profit element involved.
Insurance payouts are not linked to the markets
The amount of payouts for different insured contingencies are predetermined at the time of purchase itself. In some cases, the payouts may depend on the amount of financial burden following an unexpected contingency. Even then, most insurance plans have upper limits for the amount of payouts that the insurer will offer. For example, if you have a critical illness rider with a sum assured of Rs. 20 lakhs, the insurance provider will cover the medical costs involved in treating any critical illness covered, up to Rs. 20 lakhs.
In some cases, the benefits from your insurance plan may not be paid out at all
If none of the contingencies that are covered under your insurance policies actually occur, the insurance provider need not make any payouts at all. So, insurance plans do not always offer financial payouts, unlike investments.
But some insurance plans double up as investments too
If you’ll notice in the section above, we’ve stated that most insurance plans are not investments. Does this mean that some insurance plans can double as investments too? The short answer - yes.
More specifically, some life insurance plans can be investments too. Here are a couple of examples that explain this better.
In addition to offering a life cover, endowment plans also offer financial benefits if the insured person survives the maturity period. So, if you have purchased an endowment plan, also known as a savings plan, you can look forward to the maturity benefits at the end of the policy term. These benefits will be higher than the sum total of the premiums you paid during the policy tenure, so you can enjoy some returns on the amount paid as premiums.
Unit Linked Insurance Plans (ULIPs)
ULIPs are famous for combining the benefits of insurance and investment. You can choose to invest in the funds of your choice, such as equity funds, debt funds, hybrid funds and even liquid funds. What’s more, you can even switch funds and alter your portfolio during the policy term as needed.
So, while most insurance plans are not investments in the traditional sense of the word, some life insurance plans also double up as investments. That’s not to say that insurance cannot help you save money in many ways. Want to know the details of how you can save money with insurance? Head to the next chapter for the specifics.
A quick recap
- Insurance is a legal contract between an insurance provider and an insured person, where the former offers financial protection to the latter in case any of the insured events or contingencies occur during a specified period.
- An investment, on the other hand, is an asset or a scheme that you put your money in, with the aim of generating some periodic income or profits over the long term.
- Most insurance plans do not offer any kind of profit or gains on the payouts made.
- The amount of payouts for different insured contingencies are predetermined at the time of purchase itself.
- But some life insurance plans like endowment plans and ULIPs can be investments too
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