The purpose of insurance is risk protection; not investment returns

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

02 May 2021

Marion Wanyoike is concerned about an education insurance policy she took out for her child. She writes: “The sum assured is Sh437,000 and I pay Sh60,000 every year. The policy has a ten-year maturity period so, I am paying Sh600,000 for something that is worth Sh437,000. Is this really fair?”

When I received her email, I asked Marion whether the insurance policy is paying any bonuses and she said yes; but she wasn’t sure of the amounts. I suggested she asks the insurance company and the response was that it varies depending on market conditions but it is normally about 5 per cent per year.

Now, I have written about life assurance policies several times in this column; the last one was in December 2017. At that time, I emphasised the point that insurance is not investment. Therefore, it is unwise to assess the value of a policy on the basis of the returns that you get.

Insurance provides protection against the defined risk; in the case of life assurance, it the risk of dying. Thus, if Marion had died after making just the first payment of Sh60,000, the insurance company would still pay the full Sh437,000 to her child after the ten-year period.

Now imagine that: a Sh60,000 payment gives back Sh437,000 after ten years. This is over seven times the initial amount! It works out to about 22 per cent per year compounded interest.

And that’s not all: if Marion had opted to make her payments on a monthly basis, that is, Sh5,000 (actually, slightly higher), and then died after the first payment, then the insurance company would still honour the agreement and pay the full Sh437,000 at the end of ten years. What the rate of return now? Do the math!

In these calculations, I have not factored in the bonuses. In Marion’s policy, these are calculated at about 5 per cent of the sum assured every year. That comes to about Sh22,000 each year, or Sh220,000 over the duration of the policy.

Therefore, on maturity, the policy will pay out a total of about Sh657,000. Now it doesn’t look so unfair, does it? The extra Sh57,000 might seem little, but, we must not forget that the purpose of the policy is not to earn returns! It is to protect against the risk of losing life. The Sh57,000 is just an added bonus – it is not a return on investment. And it is called exactly that: a BONUS!