What your insurance agent will never tell you

Data from the Insurance Regulatory and Development Authority of India, the insurance regulator, suggests that 90 per cent of the insurance sold by the private insurance companies during the last financial year (April 2006-March 2007) were Unit-Linked Insurance Plans.

A Ulip has, both, investment and insurance features. A part of the premium is invested and another part goes towards paying the mortality charge for the insurance that an individual taking a Ulip receives. This two-in-one feature is one of the reasons for the popularity of this product.

The other major reason being the high upfront commission offered to insurance advisors selling the product. This leads to insurance advisors pushing Ulips more than other insurance products like term insurance.

Let us say an investor takes a 20-year Ulip. Every year he has to pay a certain premium. In the first year, 15-71 per cent of the premium can be deducted as a premium allocation charge, depending on which insurance company the individual goes to.

What this means is that if an individual decides to pay a premium of Rs 50,000 and the premium allocation charge for the first year is 30 per cent, then only Rs 35,000 will be invested. The remaining Rs 15,000 the insurance company will recover as a premium allocation charge.

The majority of this will be passed onto the insurance agent. When you compare this to the around 2-4 per cent a mutual fund agent makes on selling a new scheme, this is fantastic.

Try buying a simple term insurance policy from an insurance advisor. For those individuals who already have an investment plan in place through mutual funds, it does not make sense to buy a Ulip. But at the same time they do need insurance and term insurance policy which simply insures an individual for a certain amount for the period of the policy, is their best bet.

If the policy holder dies during the period of the policy, his nominee will get the amount for which the individual is insured, if he survives the period, he does not get anything.

Most Indians look at insurance either as a mode of tax saving or investment. Hardly anyone looks at insurance for the sake of insurance. Given this, most do not like to take on a term plan, as they do not get any money if they survive the period of the term plan.

Using this fact as a selling point, an insurance advisor usually tries to dissuade any individual from taking a term insurance policy. The main reason though is that the premiums to be paid in case of term insurance policies tend to be very low.

Also a lot of private insurance companies run contests for their insurance advisors. These contests have expensive cars, foreign trips, etc., as prizes. Insurance advisors are eligible for it only if they manage to generate a certain amount of new business for the company.

If insurance advisors are to get anywhere near having a chance of winning these contests, they can never get there by selling low premium term insurance policies. They have to sell Ulips to be eligible for prizes that these contests offer. Some insurance companies do not consider term insurance policies sold for these contests.

So no insurance advisor likes to sell term plans, which provide only insurance. In the same vein insurance advisors rarely like to sell whole life policies, endowment policies, etc.

When deciding which insurance policy to choose, an individual considers the insurance advisor as an expert and tends to go with what the advisor suggests. But this may not be the correct approach. As Steven D Levitt and Stephen J Dubner write in Freakonomics, A Rogue Economist Explores the Hidden Side of Everything, "But experts are human, and humans respond to incentives. How any given expert treats you, therefore, will depend on how that expert's incentives are set up."

The incentive of the insurance advisor is definitely not in favour of the individual wanting an insurance policy.