Beware of Bancassurance

We all know someone who has a bancassurance story, whether a recent retiree, an elderly person, or someone with minimal financial literacy.  The moment a large sum enters your account, a representative of your bank’s branch would schmooze you into buying a great investment product, which can solve all your income related problems.  

The representative would paint a rosy picture, and make unreasonable assumptions about the future without fully apprising you of the risks.  More importantly, the representative exploiting your lack of financial literacy would only mention in passing that a hefty commission would be charged from the premium that you would pay during the first three years – so much so that it may take you seven years just to break even in nominal terms.  Such is the math of bancassurance.

Bank staff prey on the vulnerable, who just want to park their funds in a safe investment product, and only later find out that they are underwater till the seventh year or so.  Savings schemes tied with a term life insurance are sold by insurance companies through banks under a nomenclature of bancassurance. Banks charge a hefty commission during the first year, often ranging between 60 to 80 percent, while the same reduces to 30 to 50 percent in second year, and a slightly lower number in the third year. 

 In-effect, if someone pays a premium of Rs. 100,000 during the first year, effectively only Rs. 20,000 to Rs. 40,000 is invested, while the remaining is deemed as income of the bank.  The illustration below further clarifies the same, where a commission of 60%, 20%, and 10% is charged in the first three years respectively.  Net return is actually what you get.

The policy holder keeps paying a premium every year, and if he is lucky finally breaks even around the seventh-year mark in nominal terms – may even remain underwater if market returns stay low.  Most buyers of such policies do not understand the math behind this, and are vulnerable to the same.  Most insurance policies sold are not even tailored to the life circumstances of policy holder.  It is entirely possible that someone who has low risk tolerance unknowingly invests in a product which has high risk.

On the flipside, if someone wants to invest in a mutual fund, the asset manager is required to conduct thorough risk assessment of the investor.  Meanwhile, such assessment does not exist in the case of bancassurance other than some half-hearted circulars.  Misrepresentation and mis-selling as rampant as representatives informally, and sometimes even formally promise returns which are well in-excess of the risk-free rate.  Such promises cannot be made for mutual funds, other than for very specific schemes.  Talking of risk-free rate, a policy holder would actually be better off just investing in a risk-free asset issued by the sovereign, which would yield a higher return than the policy, while also providing easy liquidity vis-à-vis an insurance policy.  

It may seem a bit fatalistic, but the only time a policy is actually useful is when the policy holder dies, and a death benefit is distributed to the benefactors of the policy.  If you’re not dying, chances are that investment in an insurance policy is a largely economically inefficient decision.  But how does one hedge against dying? It can be done through a term life policy, but insurance companies don’t really like marketing that product because it doesn’t generate the kind of sweet commissions that a bancassurance styled product can generate.  

Lately microfinance banks who are supposed to serve the most vulnerable segment of the population have also joined the fray and are aggressively selling badly structure life insurance policies to the most vulnerable and those with minimal financial literacy.  Extracting heavy commissions from the most vulnerable segments of society may be acceptable from a purely capitalist context, but certainly not if one has an iota of morality.

A bancassurance product is essentially a savings product bundled with a term-life policy.  Next time someone tries to sell you a bancassurance product, ask them if the investment team of the insurance company, or the senior management has also invested in the same product – high change that they haven’t.  

One can replicate potential returns of bancassurance products, and get life insurance through investing in a mutual fund, and buying a term-life insurance policy separately.  If structured well, just the tax credit from investment in a mutual fund can generate sufficient cash to pay for the term-life insurance policy.  If a low-risk mutual fund is chosen, which invests in government securities, there is a negligible chance of any capital erosion, while your returns would be higher, as your full amount would be invested, during the first three years rather than a partial amount.  Next time someone tries to sell you an insurance product, be very aware, do your due diligence, do your research, understand the product, understand the math – it is your precious money, do not be duped by men in suits.