Here's a typical scenario. An insurance agent approaches you with an investment plan that offers 10 per cent guaranteed annual income. He says the insurer can give a written guarantee mentioning this.
The confidence he exudes and the claim of written guarantee are enough to convince you to buy the plan without asking if the 'guaranteed return' is on the fund value or the sum assured (which remains the same throughout the policy period).
If this is too technical, how about asking a simple question such as the total amount you will get at the end of the policy period and how does the return compare with returns from other debt products?
Unfortunately, not many people ask these questions once the agent speaks the G (Guarantee) word.
HOW DO THE PLANS WORK?
The schemes we are talking about are endowment policies with features
similar to money-back plans. The only difference is that moneyback plans pay a fixed amount
at regular intervals throughout the policy term, while in guaranteed return plans, the policyholder starts getting money after all the premiums have been paid.
These plans offer additions/payouts as a percentage of sum assured, the amount the nominee gets if the policyholder dies. It is usually sum of the total premiums paid.
For instance, in ING Star Life, the buyer has to pay premium for three years
, and the policy term is 12 years. The minimum premium is Rs 51,728 and the minimum sum assured is Rs 1,30,000. The death benefit is different from the sum assured. It is 10 times the annual premium for entry age up to 50 years. For others, it is five times the annual premium.
The guaranteed additions and maturity benefits are paid over the last three years (10th, 11th and 12th years) of the policy term.
"The policyholder is able to lock the guaranteed returns for all three premiums paid over the 12-year policy term," says Kshitij Jain, managing director and CEO, ING Life Insurance
A similar plan, Kotak Assured Income, where the premium-paying term is 15 years and the policy term is 30 years, promises 9.10-10.10 per cent annual income from 11th year onwards.
Aviva Life Insurance recently launched a plan-Aviva Family Income Builder-which pays double the annual premium from 13th year onwards. The policy term is 24 years and the premium-paying term is 12 years.WHAT'S THE CATCH?
Claims such as 'guaranteed income' and 'doubling of money' are made to add spice to an otherwise not-so exciting product.
First, the 9-10 per cent guaranteed addition starts only after completion of a certain period-10 years or more in our earlier examples. This, however, is mentioned in the policy brochure only in fine print.
"The core purpose of the product (Kotak Assured Income) is to encourage long-term savings and supplement the income of the customer. To serve this purpose, guaranteed income starts from the 10th policy year," says Suresh Agarwal, executive vice-president and head of strategic initiative and distribution, Kotak Mahindra Old Mutual Life Insurance.
The guaranteed income/addition is paid on the sum assured and not the fund value. The sum assured remains the same throughout the policy term while the fund value keeps rising with time. This means investors do not benefit from compounding of returns.
What these schemes promise is far removed from the returns they offer. Sample this. Aviva Family Income Builder, which claims to 'double your annual premium', does so in 12 years. Suppose that you invest Rs 1 lakh every year for 12 years.
From 13th year onwards, you will get Rs 2 lakh a year for the next 12 years. A simple calculation shows a compounded annual growth rate of 6 per cent. The returns are tax-free, though.
In Kotak Assured Income, you pay Rs 20,000 a year for 15 years and get a total of Rs 5,78,000 in the next 15 years, This means Rs 3,00,000 becomes Rs 5,78,000 in 30 years.
In ING Star Life, you pay Rs 1,02,048 a year for three years and get Rs 5,50,000 (against an investment of Rs 3,06,144) in 12 years.
6 PER CENT
is the annual return from most traditional endowment plans.
Considering that these plans are sold as an investment option, their returns are not only unexciting but also disappointing, even if they are tax-free and the investments are eligible for income tax deduction under Section 80C of the Income Tax Act.
Kartik Jhaveri, director, Transcend Consulting, a wealth management company, says, "One must know that these are not guaranteed return schemes, they are guaranteed payment schemes. No insurance plan can guarantee 9-10 per cent annual return."
He says as these are traditional endowment plans, which invest mostly in government debt, they cannot generate more than 6-7 per cent annual return.
If returns from these products are disappointing, the insurance cover is no better. While ING Star Life and Kotak Assured Income offer death cover of 10 times the annual premium, Aviva Family Income Builder offers death cover of 24 times the annual premium if the person dies after the first policy year.ALTERNATIVES
If your aim is wealth creation without taking too much risk, these schemes should be the last on your priority list.
Tax-saving bank fixed deposit schemes, whose tenure is at least five years, are offering up to 8.5 per cent a year, and generate much higher tax-adjusted return than any scheme discussed earlier.
The tax-adjusted return from the fixed deposit scheme for a person in the 30 per cent tax bracket would be 14 per cent. This is much more compared to Aviva Income Builder's 9 per cent.
Gaurav Rajput, director, marketing, Aviva India, counters this argument. "You are assuming that interest rates on fixed deposits will remain constant in the years to come, which may or may not be the case. It is important to note that an insurance product like Family Income Builder ensures that you have funds available for your family's future financial needs whether you are around or not. No other financial instrument can ensure this," he said.
It is true that there are few long-term debt products that offer tax-saving as well as give tax-free returns. This, however, does not make traditional insurance endowment plan an ideal investment for risk-averse investors.
If you plan smartly, you can create a decent corpus by using fixed income tools such as bank fixed deposits, Public Provident Fund, Employee Provident Fund, Fixed Maturity Plans, tax-saving bonds and non-convertible debentures, all of which offer up to twofour percentage points higher return than the traditional endowment plans.
The inherent problem with endowment insurance plans is that they neither serve the purpose of providing enough cover nor help in creating a healthy corpus.