Planning To Buy Child Insurance? Think Twice

As a parent, one of the first things you would think about your children’s future is planning for their education expenses.

According to the recently published HSBC Quality of Life Report 2024, while 53 per cent of Indian respondents have an education savings plan for their children, 40 per cent expect their child to take student loans, 51 per cent are hopeful they will get scholarships, and 27 per cent would consider selling assets to cover the education costs of their child.

While the report does not mention the kind of education savings plans parents invest in, children’s insurance plans are quite popular in India.

These insurance plans are often sold as one-stop solutions to gullible parents, who do not realise that they may not give them optimum returns, which they should be looking at for their children’s education. To be sure, education inflation is higher than normal inflation at 11-12 per cent, according to the BankBazaar Aspiration Index. So if a four-year engineering course costs Rs 25 lakh now and your daughter is 5 years old, it could cost about Rs 1.09 crore when she is 18.

These numbers may sound scary, but with proper planning, you can secure the future of your children. But first let’s assess if children insurance plans can do the job.

What Do Child Plans Offer?

There are two types of children insurance plans. One, unit-linked children insurance plans (Ulips). These Ulips invest part of the premium in market-linked instruments and offer returns based on market performance. Two, endowment children insurance policies, which are traditional plans that offer guaranteed returns and carry lower risk than Ulips.

“Child insurance plans are designed to secure a child’s financial future by providing funds for major life milestones, such as higher education and wedding. These plans offer benefits that can be received either as a lump sum or as a regular income stream to cover education expenses over four-five years, or as long-term financial support,” says Vaibhav Kumar, senior vice-president and head, product management and e-commerce, Max Life Insurance.

They also offer tax benefit. Says Nehal Mota, co-founder and CEO, Finnovate, a financial planning firm: “There are tax benefits under Section 80C of the Income-tax Act, 1961 on the contribution (if you opt for the old tax regime) of up to Rs 1.5 lakh per annum and under Section 10 (10) on the redemption value. The redemption is fully tax-free if held for at least five years. Apart from these, there are also loyalty benefits in the policy, which allow you to enhance the value of the policy.”

What Makes Them Popular?

First, child insurance plans provide a financial guarantee. In endowment plans, the returns are guaranteed. In Ulips, there is potential for higher returns. However, in both cases, the sum assured or the payment that one would receive in case of the policyholder’s death or the policy’s maturity is guaranteed.

Second, they provide dual benefits in the case of the policyholder’s demise—the sum assured as well as continuation of structured savings.

Says Aditya Mall, appointed actuary, Future Generali India Life Insurance: “In the unfortunate event of the parent’s death, these plans ensure that the child’s financial needs are met through both the life cover and the accumulated savings. A key feature is the premium waiver, where future premiums are waived if the policyholder passes away, but the policy remains active, guaranteeing that the child’s financial goals are still achieved.”

What this essentially means is that the child benefits from the policy without placing any additional financial burden on the family. “In the event of a loss, the child still receives the assured sum or accumulated benefits at maturity,” says Madhupam Krishna, a Securities and Exchange Board of India (Sebi) registered investment advisor (RIA) and chief planner, WealthWisher Financial Planner and Advisors.

To put it simply, in a child insurance plan, the sum assured is typically paid out immediately upon the death of the parent, who is usually the policyholder. This is the insurance part of the plan, and accumulated benefits are received at maturity. The accumulated benefit is fixed for endowment plans, and market-linked for Ulips.

Third, both endowment plans and Ulips come with a lock-in period—usually five years—during which time you cannot make any withdrawals. If you surrender in this period, the penalties would be high. However, you can make partial withdrawals after the lock-in period.

This feature is often pitched as one that will guarantee regular and forced savings. “The intermediaries bet on your indiscipline in investments. They will stress that since mutual funds have no lock-in, you may withdraw at the next requirement or nudge, spoiling the plan,” says Krishna.

Should You Invest?

Commissions play a role when insurance plans are sold. The higher the premium, the higher will be the commission. “Lack of knowledge (on the part of investors) of both term plans and mutual funds is a major hindrance. Agents are not interested in selling term plans as the premium amount is less, and so is the commission amount,” says Krishna.

It Mixes Insurance With Investment: If there was a list of financial planning mistakes one could possibly make, mixing insurance with investment would top it. Says Chirag Muni, executive director, Anand Rathi Wealth: “Insurance and investment are completely different financial products, and investors should never mix them. The objective of the investment product is wealth creation, whereas the primary objective of insurance is to protect against unexpected financial loss.”

Sub-Par Returns: When investing for your child’s future, you would want to get good returns on your investments. But with child insurance plans, the truth is different.

In endowment plans, the returns are lower than the average inflation figure. In Ulips, the returns may beat inflation, but the returns are not guaranteed.

“Traditional plans offer 4-5 per cent overall returns. This means that, let alone education inflation, the returns of these plans hardly beat the general inflation figure. Returns from Ulip child plans range from 9-11 per cent depending on the economic cycle, management of the funds using the free switch facilities, and the tenure of investments,” says Krishna.

So, if you want guaranteed returns, you will have to settle for very low returns, and that is not viable. In case you are willing to take some risk, mutual funds are a much better option than a Ulip, but we will talk more about that later.

Unclear Communication: In fact, the specific rate of return isn’t always clearly stated in marketing material.

“These documents often provide estimated maturity amounts tied to various premium payment scenarios, which can create uncertainty for potential policyholders. The brochures show time-weighted returns, whereas policyholders will get money-weighted returns. The difference between these two is actual returns and returns generated net of charges and expenses,” says Krishna.

Calculating the internal rate of return (IRR) is essential for evaluating the financial effectiveness of a child plan in India. This involves examining the cash outflows, which are the premiums you pay, against the cash inflows, represented by the maturity benefits you receive at the end of the term.

Gaining insights into the IRR can greatly assist in determining whether a child plan meets your long-term financial objectives, helping you make a more informed investment decision. However, calculating IRR requires a complex formula and you will not find this in the brochure of child investment plans.

The story is the same for costs. Says Gaurav Goel, entrepreneur and Sebi RIA, “We have generally seen that costs and returns are not explicitly reflected in the selling brochures.”

The cost can be higher, especially when it comes to Ulips. Many of the Ulips have high loading and the total expense ratio (TER) turns out to be steep over time.

What’s The Alternative?

If you want to secure the future of your child and also protect him or her against any unforeseen event, some other investment options may make more sense.

Says Krishna: “Separation of investments through a term plan and investing in mutual funds and equities can help. A term insurance policy will provide high coverage at a lower premium, thus ensuring financial security for the child without draining the investment capital. Investing in mutual funds, especially equity funds, can offer better returns than the conservative nature of child plans.”

Agrees Renu Maheshwari, Sebi RIA, principal advisor, Finzscholarz Wealth Manager, “A regular mutual fund with an appropriate risk-return profile will give far better results.”

Now let us see how a combination of a term plan and mutual fund investments can be a better option.

Let us first look at the insurance coverage that child plans provide. “These plans have inadequate amount of insurance. One often needs a big cover, especially when one has started a family or taken a liability like a home loan,” says Krishna.

When it comes to a term plan, you can get a much higher coverage for a lower premium. For a premium of as low as Rs 10,000 a year, you can get a life cover of Rs 1 crore, depending on certain factors, such as age, health, income, and so on.

But doesn’t a premium waiver that child insurance plans provide a huge benefit? It is a benefit, but not one that can’t be compensated for by taking a large term cover, which, as shown earlier, can be had for a much lower premium. Think of a larger sum assured in a term plan that covers both the components—the sum assured payout in the event of death or disability of the policyholder, and the final accumulation after the waiver of premiums. This will take care of the protection part.

For the returns part, mutual funds have the potential to offer substantially higher returns than what a child insurance plan will provide (see What Do You Get?).

In endowment plans, as we have seen, the returns will not even be able to beat inflation, but even Ulip child insurance plans have not been able to beat mutual fund returns, historically, due to multiple reasons, such as charges for the insurance component, and so on.

Mutual funds have provided better returns historically because of their focused investment strategies and lower fees.

Let us look at the returns of a BSE Sensex index fund. Since these funds track the Sensex, the fund management charges of such funds are very low. Such funds have given a return of about 17 per cent in the last five years.

If you plan your mutual fund investments and invest in a mix of large-cap, mid-cap, and small-cap funds, you can potentially earn a higher return on your investments.

However, child plans score on the tax benefit aspect. Not only do they offer tax deduction benefits, any churn in the portfolio is tax-free, especially when it comes to Ulips. “The big advantage of a child plan is that the churn (of funds) does not impose any tax burden on you. However, if you handle the combination of insurance and mutual funds, you face tax liability each time you churn the portfolio. Normally, this is the key trigger in favour of a child plan,” says Mota.

Professional guidance, however, can help you ride the market ups and downs, and the need for churn, making your investment in a mutual fund more tax efficient and ensuring a higher return.

meghna@outlookindia.com