Insurance is not investment: you get less than what you pay

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

24 December 2017

Many people get a rude shock when their life assurance policy matures and they find that the final payment is less than the total premiums they had paid for it. The problem is that insurance sales agents present these products as investments and clients buy them believing that they are investing. Well; the truth is very different.

There is a reason why life policies are called “assurance” (instead of “insurance) and the earning from them are called “bonus” (instead of “interest” or “returns”).

When you buy (note; not “invest in”) a life policy, what you get for your money if the “assurance” that, if you die before the agreed time period, your beneficiaries will be paid a certain amount of money. This money is called the “Sum Assured”. If your life doesn’t end before the agreed date, then you get the Sum Assured.

When you think about this transaction, the only way the insurance company can make a profit is if the money you are paying is MORE than the Sum Assured! Obvious, isn’t it? If that was not the case, the company would go bankrupt in a short time.

Let us look at it from first principles. Suppose you buy a Sh500,000 life assurance policy for which you pay over a period of ten years. The agreement is that, if you die any time after making the first payment, then the Sh500,000 will be given to your beneficiaries.

Ideally, the insurance company must take Sh500,000 of its own resources and place it in a trust account in your names. That way, if you die, the money is paid to your beneficiaries without undue delay.

The question is: how much will you be charged for this “assurance”? That is, what is the assurance “premium” payable? Now, the name “premium” was chosen carefully. It immediately implies that you will pay a “premium”; that is, more money than what you will get back!

The typical rate for such a policy in the Kenyan market today is about Sh5,000 per month. Thus if you don’t die, you will have paid a total of Sh600,000 (= Sh5,000 x 12 months x 10 years) by the time the policy matures. This is less than the Sh500,000 you have been assured of.

But the insurance company wants to be fair to you. The Sh500,000 siting in the trust account is earning some interest. The earnings belong to the insurance company because it is their money. However, they decide to share some of that return with you. Thus it offers to pay a “bonus” over and above the sum assured.

This bonus is calculated on the sum assured; not the premium! Typically, in Kenyan, insurance companies offer a minimum of 2% per year bonus. Now; 2% of Sh500,000 is Sh10,000. Thus over ten years the bonus is Sh100,000.

When you add the Sh100,000 bonus to the Sh500,000 sum assured, you get total payment of Sh600,000 – exactly the same as the combined premiums that you paid!