One of my cousins recently called me to know where to invest for his newborn son. He is in late 20s and wanted to start saving for his higher education. The fact that he wants to start saving from the very first-year itself made me feel very proud of him. This is because I know many parents who are still thinking about starting investing when a child is just a few years away from her or his college. If they have not done by now I am assuming they will never be able to do it. But my happiness soon faded when he said that he wants to invest in a traditional plan. The plan was suggested by one of his friends who claimed it to be one of the best financial products for investment. I immediately dissuaded him from buying a traditional plan as there is a serious need of intervention from the regulator to make traditional plans more customer-friendly.
My first line of argument is that they are not transparent. The charge structure of endowment plans is not declared by insurance companies upfront. The Reason: the regulator does not ask them to do so. There is no split of premium in endowment plans to tell you how much goes into mortality and investment, which is a huge disadvantage for a customer. Experts say the regulator is working towards it. But if they are, they are working at a very slow pace
Second, returns should be disclosed in a far transparent manner. Benefit illustration in non-participating plans does not make much sense when the one doesn't know bonus that the company is going to pay to the policyholder. Moreover, when on one hand mutual fund industry is moving to adopt more transparent benchmarks such as Total Return Index, which is basically an index which captures both the movement in the stock price of the underlying companies as well as the dividend paid by the companies to the investors, the insurance industry has not been following the basics of personal finance.
Having said that returns in endowment policies are still defined as percentage of sum assured and not as percentage of investment made by the policyholder. So, the investor never knows how much she or he is actually getting from investments. The brochure may say that it will pay you 10 per cent of the sum assured but when you actually calculate the return from your endowment policy might not be more than 4-5 per cent.
Third, the portfolio. Insurers are not bound to disclose their portfolio so we do not know where our money is getting invested. Currently, when the banking industry is sitting on huge NPAs we do not know how much NPAs could be in the books of your insurer.
Last but not the least, high surrender charges. Policyholders should know very clearly the consequence of exiting an endowment policy earlier than maturity. This is important because in many cases a traditional policy takes as long as 8-10 years to achieve a break even.
As the Sumit Bose Committee said "traditional plans were manufactured in the post colonial era when the economy was in a nascent stage with undeveloped capital and bond markets.... The lack of alternate products made this product the only vehicle for corpus targeting households. The product served its mandate well enough. However, over the years as markets have become sophisticated, financial products have reflected the change in the economy with features like investments getting marked to market to reflect the true value of the investment portfolio on a real time basis."
It is time for the regulator to pick up some pace and alter traditional plans to make them transparent suiting the needs of policyholders.
PS: I advised my cousin to invest in a combination of term plan and mutual funds. Not only they are simple but also most cost-efficient.