We have pointing out in this Blog that life insurance endowment is the best long term savings option for long term financial needs. One of the principal reasons for this is that it is low risk (not necessarily low returns). The question that arises next is that bank fixed deposits are also low risk, then why not invest in bank fixed deposits.

A Fundamental Principle in Financial Planning and Management

To answer this question we must go back to am fundamental principle of financial planning. If a financial liability is likely to arise after 15 years, we must invest in a low risk asset that matures after 15 years. If we invest in a financial asset that matures in 10 years or 5 years, the chances are that we will not have the money when we need it. The chances are that the money maturing in 5 or 10 years will be used for purposes other than what has been planned for.

The Concept of Asset Liability Matching (ALM)

This is embedded in the concept of Asset Liability Matching. In financial planning matching future financial liabilities with future financial assets, is a prudent and wise method of financial planning. Individuals do it all the time, without being told to do it. As per Handbook of Statistics published by the RBI, approximately one-third of all savings in the country is saved for the long term needs, such as life insurance, provident fund and public provident fund and pension funds.

Investors are Wise

Individuals are wise enough to know that one has to save in long term financial assets such as provident fund and life insurance endowment, etc., so that they can enjoy their future years, free of financial worries. Those individuals who do not create asset liability matching. usually end up having serious financial worries in their old age.

Organisations also have to follow the same principle

Organisations also do it all the time. A life insurance company for example, pays out maturity claims every day. How is it that the company has the money to pay their policy holders exactly at the time the payment is to be made 20 years after the policy term began? Organisations go through an exercise of Asset Liability Matching (ALM) to ensure that claims are settled when they arise, 15/20/25 years later.

Those not following ALM face serious future problems

Some organisations do not go through such a calculation and face serious problems in their financial management. In the recent days for example, the NBFCs took short term loans and deposits (their financial liabilities) and lent in long term loans (their financial assets) to their customers. The result was that the persons or organisations that gave money to the NBFCs started demanding their money on maturity. This maturity was for around 5 years. On the other hand the money that was loaned to the customers of NBFCs would pay after 10 to 20 years. The result was an Asset Liability mis-match.

The NBFCs are in serious trouble

The Asset Liability mis-match in the NBFC sector is now a major problem. Many NBFCs, may close down. They are all asking banks for money to get over the crisis. The banks in turn are in their own financial troubles and are unwilling to lend to the loss-making NBFCs. The NBFCs are in serious trouble because they did not follow a fundamental principle in financial management – that of Asset Liability Matching.

Planning your Customer’s Future Long Term Needs

Ensure that your customers follow Asset Liability matching. Identify their long term needs and show them how life insurance endowment is the best option for long term financial planning. Fixed deposits in banks are good as a low risk savings option for short term needs. But for long term needs, with low liquidity, and low risk, life insurance endowment is in fact the only option.

Sell Risks Not Returns