It is better to pay insurance premiums annually instead of monthly

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

04 January 2009

Apart from the issue of power consumption by different appliances that was discussed last week, Judy Nyanjui had also asked about the payment of insurance premiums. Her question was equally straightforward: “Which is cheaper; paying my insurance premiums monthly or yearly especially the education or life policy?”

The answer to that depends on the insurance company you are using. Mine offers a one month discount for payments made annually. That is you pay for 11 months, but they enter in the record that you have paid for one year. This works out to an 8.3 percent discount.

That might look small at first sight, but when we bear in mind that life insurance is for the long-term, the numbers change dramatically. Take a ten-year policy for instance; If you get a one month discount in every year, then by the time the it matures, you will have saved 10 monthly premiums.

In addition, you also make a substantial gain on your return on investment when you choose to make annual payments. Let me illustrate with a real example: If you are under 30 years of age and you take out a ten-year, Sh100,000 education policy with my insurer (name withheld), you will pay Sh1,114 per month. The estimated maturity value for the cover is Sh196,000.

Now, if you choose monthly premiums, you will pay a total of Sh133,680 over the term of the policy. This grows to Sh196,000 on maturity – a 47% increase.

On the other hand, if you make your payments annually, it will cost Sh12,254 per year, or Sh122,540 over the term of the policy. This will still grow to the same Sh196,000 on maturity. The reason is that, the earnings are calculated in the sum insured (i.e., Sh100,000) and not on the premiums paid. The return on investment in this case is 60 percent.

Nonetheless, what surprises many people is that the returns from insurance premiums are so little that it seems better to keep the money in the savings account at a bank. In the above example, you make a 60 percent return on a ten-year investment. If you had bought a plot of land…

This comparison misses two important points. The first is that this is an INSURANCE policy, not an INVESTMENT scheme. The profit is a bonus; and indeed, most insurance companies actually call it that!

As an insurance, if you made just one payment (whether monthly or annually) and then you died, the company would continue making payments to the policy on your behalf until maturity. At that point, your child would be paid the Sh196,000 – no questions asked, apart from confirmation that she is indeed the your daughter.

The second point is that the “investment” is not done at one go: The payments are made slowly over a long duration. If you bought land, for example, in instalments for ten years, you’d probably end up paying three to five times the original value – ask anyone buying a house on mortgage.