In the last article, we saw how Aadeshna calculated the returns on her mother’s “Cash Value” insurance policies. (Click here to access the article.) And she was shocked to find that not one of the multiple policies her mother had subscribed to gave returns in excess of 6% which meant that the money invested would only double in 12 years (calculated using the “Rule of 72“).
Now, what are “Cash Value Plans”?
The Cash Value Plans are those insurance policies which typically have two parts:
- Risk Cover
- Savings Component
The risk cover part provides you with the death benefit. Say, a policy holder has an insurance coverage of INR 1 crore. That means that the risk coverage is of 1 crore implying that in the event of death, the nominee of the policy holder – typically a family member – would get INR 1 crore.
And the savings component ensures that you receive a a lump-sum at the end of the policy coverage period or get an annual survival benefit every year. Sounds great, right?
But it is not.
This brings us to lesson number 2 (Click here for lesson 1):
Keep It Simple, Stupid! – the KISS principle designed by the US Navy in 1960
Insurance companies, like any other company, exist to make profit. They are not into charity. That you would receive a lump-sum or an annual survival benefit does not mean that the insurance companies are paying you out of their own pockets. They are making you pay for it. How?
Through your premiums!
This is why premiums of cash value plans are on the higher side as compared to the premiums of the useful “Term Insurance” plans which just do one thing: provide risk coverage. Typically, the premiums of cash value plans are 2 to 3 times the premiums of term insurance plans.
And it is the difference in the premium amounts which is used to provide you with the cash-back at the end of the coverage period.
To know more about the differences between cash-value plans and term insurance plans, wait for the next post!
P.S.: The motive of the post is not to show that getting insured is not necessary. That is absolutely not true. Getting insured is imperative. But there is a better way to get insured which shall be discussed in the subsequent posts of this series on Insurance.
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Categories: Learning Money