A life insurance scheme should not be judged by the interest it pays

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

06 May 2007

John Wambua is having troubles figuring out how much return he is getting from his insurance policy. He says that the insurance company will “deduct Sh 2,500.00 from my pay every month for the next fifteen years, and then pay me on the fifteenth year a lump sum which (is) almost double the principle. Please help me, is there a better plan?”

The word “better” can be misleading: it can mean a higher return on the investment or greater security. The second meaning depends on the life insurance component of the scheme – that is, what happens in case of death or permanent disability etc? That information can be obtained from the policy document and compared with offers from other companies.

The first meaning is probably easier to evaluate: it involves calculating the rate of interest that Wambua is getting from the investment. A quick way would be to find out how much the total capital is and then compare it to the lump sum payment at the end of 15 years.

Thus: Sh 2,500 per month for 15 years (180 months) comes a total of Sh 450,000. In Wambua’s own words, the pay out is “almost double the principle”, that is approximately, Sh 900,000, or a 100 percent return. With this figure, it is tempting to calculate the average annual return straight away…but all that would be wrong!

The reason is that the Sh 450,000 is not invested at once. It is paid gradually on a monthly basis. Thus at the end of the first year, for example, Wambua will have put in only Sh 30,000 into the scheme. Taking this into consideration, it turns out that the average return is about 8.5 percent per year.

Now that might seem small but in fact it is very high. The highest earning Money Market Unit Trust is currently paying about 7 percent per year. Even without considering the insurance component of the scheme, I would advise Wambua to go for it.

However, he must establish whether the stated return is guaranteed in the contact document or it is just a historical figure quoted in the sales material. Nevertheless, an insurance scheme is supposed to take care of you when something bad happens; the interest payment is only a bonus to make it more attractive. Consequently it should not be evaluated on the basis of how much you get at the end of the period, but rather on what it pays in the event of death or permanent disability etc.

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It was reported in the press this week (Daily Nation, Thursday 3rd May 2007) that Derrick Mutisya of Mombasa has invented a machine that generates electricity and uses the same power to run itself. I haven’t seen the contraption but here is my immediate reaction: only nothing can come from nothing and something can only come from something else. Thus I would be interested to know how Mutisya’s “Galaxy 6-2-6” was started in the first instant.