Just as interest is earned on savings when you deposit money in a bank, bonuses are also provided in life insurance with savings. However, there is a difference between the interest paid in a bank and the bonus of insurance.
The first difference is that the interest of the bank is predetermined. Which depends on the liquidity of the market, but the bonus rate of life insurance depends on the profit earned by the life insurance company. Therefore, insurance with savings is also defined as a type of insurance plan that participates in the profit.
The life insurance company is required to declare at least 90 percent of the profit under the life insurance fund annually for the bonus of the insured. Since the bonus is declared according to the annual profit, the bonus rate is not fixed at the time of insurance and the bonus rate may also fluctuate annually. The bonus rate remains constant unless there is a very adverse situation or a major change in regulation.
The second difference is the base value for which the bonus is declared. While bank interest is provided on the deposited amount, life insurance bonus is provided on the insurance premium and not on the insurance premium. For example, if you deposit 1 lakh rupees annually in a bank, the interest on 1 lakh rupees is calculated, while in insurance, the insurance premium of 1.5 lakh rupees is 1 lakh rupees, and the bonus is calculated on 1.5 lakh rupees, not on the insurance premium. In some cases, this is even promoted, and it is said that insurance gives higher returns than banks.
Does it really give more profit than banks?
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## The main investment area of life insurance is term deposits. To understand it simply, the insurance company collects money from the insured and invests it in the bank’s term deposits. Under which the bank pays interest. Which is shared between the insured and the insurance company. It is completely wrong to explain that the share of return received from the bank is more than the entire return of the bank. Moreover, since there is a separate expense for bearing risk in insurance and the management expenses including insurance agent commission and incentives are high, it is not possible to have a return on life insurance that is more than the interest of the bank after deducting these expenses.
While it is said that the bank pays interest only on the money deposited, one thing that should not be forgotten is that the bank’s interest is received quarterly, but in life insurance, the bonus is received in a lump sum only at the end of the insurance period. Therefore, if we are to compare life insurance, it is more appropriate to compare it with a recurring deposit, which is not subject to interest withdrawal, and where annual or monthly amounts are deposited and a lump sum is received at the end of the period.
For example, if a person takes out a 15-year life insurance policy with a sum assured of Rs. 1.5 million, his annual insurance fee will be around Rs. 1 lakh. The bonus of which is 60 per thousand, or 6 percent, in today’s situation. With a 6 percent annual bonus, at the rate of Rs. 90 thousand per year, 13 lakh 50 thousand is received in 15 years, a total of 28 lakh 50 thousand. This means that 6 percent of the sum assured. However, if we consider the insurance premium as less than 8 percent, that is, if we deposit 100,000 rupees annually in a bank’s regular deposit at 8 percent interest, it will be about 3 million rupees. Now, with the interest rate decreasing, 8 percent seems too much. However, until a few months ago, the interest rate was more than 10 percent. Under which this amount will be more than 3.6 million rupees.
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## ##Impact of falling interest on insurance bonus
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## In an advanced economy, the interest rate of the bank is stable and even a small change has a big impact. However, in the case of Nepal, the interest rate is found to be very unstable. While in the previous fiscal year, the bank announced an interest rate of more than 13 percent on deposits, this year the interest rate has been fixed at 3 percent. Since the main source of investment of a life insurance company is bank deposits, its direct impact on the insurance bonus will also be felt. However, does the insurance bonus also decrease as the bank’s interest rate decreases?
There are two reasons why the insurance bonus does not decrease at the same pace when the bank’s interest rate decreases. The first reason is the term of life insurance. Since life insurance is a long-term contract, insurance companies can keep the amount received from the insured in a fixed deposit for a long period. For example, when the interest rate was high last year, the life insurance company had already invested in the same deposit for a long period. Due to which, even if the current interest rate is low, their investment in the same interest rate as the previous year is locked for a period of 10-15 years.
Another reason is the pooling of investments. Just as the main principle of insurance is the pooling of the insured’s risk. Similarly, savings are also pooled. For example, whether the insured comes to insure when the bank interest rate is 13 percent or the insured comes to insure when the bank interest rate is 3 percent, the bonus rate for both will be the same in the same insurance plan. Therefore, due to these two reasons, there is no immediate situation where a drop in bank interest rates will cause a major change in the life insurance bonus. However, if this situation continues, there is a certain possibility that the life insurance bonus will also decline significantly.
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## ##The way forward: Life insurance for those without savings and investing elsewhere
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## In life insurance, an insurance plan that only bears the risk seems beneficial for both the insurance company and the insured, rather than insurance with savings. From the perspective of the insured, in insurance with savings, not only are you forced to insure a much lower sum assured than you need, but the return from your savings share is also very low. In such a situation, neither the risk is well-managed nor is a good return on investment achieved. Therefore, by taking out a term life insurance policy with a small premium for the sum assured you need and investing the remaining amount elsewhere, you can both bear the risk as required and get a good return.
Similarly, from the perspective of life insurance companies, an insurance plan that only bears risk seems more appropriate in the long term than an insurance plan with savings. Even though insurance companies are issuing insurance plans with savings and bringing in billions, they are earning much less profit compared to that. In insurance plans with savings, 90 percent of the profit has to be given to the insured, a decrease in the announced bonus rate will have a negative impact on the market, insurance policies issued by force will be surrendered, and on top of that, the bank’s interest rate is very unstable. Due to these reasons, insurance companies are not able to get the expected returns from insurance plans with savings, and the insurance industry itself has become bankrupt. In such a situation, insurance companies need to consider the option of savings-free life insurance.
