You wish to buy a house in, say, a couple of years, so you want to start putting some money away. Where will you invest? A two-year horizon may be too risky to think of stocks. A debt product such as a fixed deposit offers more comfort in this case: it shields your money from market swings and offers assured return. To reach a goal so near in the future, capital protection may be the important focus; return on capital is perhaps incidental.
Now flip the argument and think of a long-term goal such as retirement, which is a good 10-20 years away. Where will you invest? A long-term horizon gives you more confidence to dabble in equities: over the long term, equity as an asset class tends to surpass all other asset classes. You could even look at long-term debt products that offer a real rate of return—above the inflation rate. The focus in this case should be to pick assets that enhance value and keep you ahead of inflation.
This is the basic tenet of personal finance: for short-term goals look at safer assets to get capital protection, and for long-term goals look for riskier assets to get a real return on investment. Guaranteed insurance cum investment plans don’t fit this tenet and yet are popular in the insurance industry. These are long-term plans, typically, with policy terms of 10 years or more, and offer a guaranteed return of around 4-5.5%.
Mint Money gets you the industry perspective on these plans and what the financial advisers make of them. Read on.
Why go for it
To begin with, guaranteed plans fall under the category of traditional insurance-cum-investment policies. Traditional policies are characterised by opaque structures but come with a minimum guarantee and usually a basic insurance cover that entitles the plan for tax benefits. Guaranteed plans fall under the non-participating category of insurance-cum-investment plans that guarantee the investment benefits upfront.
These policies can be variously structured. You can choose to get a lump sum at the end of the policy term. If you choose an income plan, you get a fixed periodic income for a certain number of years after you pay the premiums. You can also choose a combination of both.
While the benefits are fixed and mentioned up front, what these plans don’t disclose is the net return on your investment.
Mint has decoded several of these products. For most of these, the net return on investment has been about 4%. For some it goes up to 5.5%. Insurers peg the average between 4.5% and 5.5%.
According to insurers, looking at net return alone and ignoring the key benefit of a guaranteed return is a mistake. “No financial instrument other than a guaranteed life insurance product offers guaranteed return on future new money (the annual premium that you pay every year). Insurance coverage and tax benefits are added advantages,” said Mudit Kumar, chief and appointed actuary, Bharti AXA Life Insurance Co. Ltd.
This line of reasoning seems to have gained traction with customers. “In the Indian context, guarantee has been the single largest motivation when it comes to investment and the same is evident from the contribution of household savings to bank deposits and post office instruments. The guaranteed plans are preferred by urban customers beyond age 35 in the middle- to higher-income groups. The conservative customers prefer this as a primary or natural choice and those with high-risk appetite treat this as a hedging instrument against the riskier investments,” said Anjali Malhotra, chief customer marketing and digital officer, Aviva Life Insurance Co. India Ltd.
Plus, these plans shift the investment risk to the insurer, so even if the interest rates fall (they are on a downward trend at present), customers are not impacted. “With globalisation of the economy, interest rates in India are likely to get affected. These plans help pass on the investment risk to the insurer,” added Sunil Sharma, appointed actuary and chief risk officer, Kotak Mahindra Old Mutual Life Insurance Ltd.
Agreeing with this, Kumar added: “Imagine, after 20 years when interest rates are expected to be 3% as per the current trend, a customer receiving a return of 4.5-5%. In markets like Japan, where current interest rates are negative, customers are enjoying a positive guaranteed return.”
Accordingly, insurers find them suitable for long-term goals, and conservative investors. “These plans need to be linked to key financial milestones and treated as a separate asset marked for specific purposes. When taken for long-term life goals, they ensure that goals are met without uncertainty or dependence on investment’s performance,” said Malhotra.
Should you buy?
Financial advisers, however, see little merit in these arguments. To begin with, guaranteed plans give low returns and strain the present income to reach a future goal. Here is how:
If you want to accumulate $1 mil at the end of 15 years, at 4.5% you need to invest about $46,000 every year. Compare this with mutual funds, where $34,000 a year at 8.0% (average return rate) can give the same return. The downside in mutual funds is that the future rates are not guaranteed. The upside is that you start by investing less. I would recommend mutual funds even under a falling rate regime because the rates can be higher and your money will compound at that rate at least in the initial years,” said Surya Bhatia, a Delhi-based financial planner.
The other problem with these plans is that their rate of return is well below the market rate and they don’t cater to the long-term investors’ need for staying ahead of inflation. “I don’t recommend buying into a guaranteed lower-interest rate today in anticipation of a future cut.... Currently, the risk-free rate is about 7% and these plans are offering a rate much below that,” said Bhatia. “For someone to lock into a 4-5% rate over a 10-20-year horizon, the view would be that interest rates will come down and stay low for a long period. It’s hard to take interest rate calls for such long periods. If you have to pick debt products, pick ones where the interest rate at least matches the current inflation rate,” added Bhatia.
Many also find flaws with the bundled nature of these plans. “First, the element of insurance is negligible, and second, we have seen a sharp decrease in the cost of term plans (pure insurance policy). With a term plan you can simply switch to a cheaper plan, but the same flexibility is not there in a bundled plan. You will have to surrender the plan and pay a huge surrender charge in case of a traditional plan,” said P.V. Subramanyam, a chartered accountant and financial trainer.
The opacity of the product is also a problem. “Usually, the cost of guarantee is around 75 bps (basis points). So, if the underlying asset class is giving a rate of 8%, the actual rate of return will be 7.25% in a guaranteed plan. However, these plans shave off more and this money goes towards distribution costs and reserves of insurers,” said P. Nandagopal, founder, www.insuranceinbox.com, a n online insurance broker. “Invariably, in opaque situations these plans end up diluting customers’ value to meet the distributor and shareholders’ expectations,” he added.
Further, though the word guarantee sounds comforting, these plans have risks. “Customers run the risk of suboptimal returns. One would be better off taking market risks, which one can mitigate... by investing for the long term and diversifying the portfolio,” said Nandagopal.
We agree. For long-term goals, guaranteed plans should not be your focus. Further, poor disclosures in the case of guaranteed insurance plans make the choice worse. - livemint
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