Investing – A really bad idea

Publication: The Times Of India Mumbai; Date: Apr 22, 2008; Section: Your Money; Page:40

WHO would buy a product which has a minimum 35% cost in the first year and 5% from second year onwards, with a return of only 5-6%? You’d think not many sane people would do it. Yet, time and again, countless people buy such products for the wrong reasons,likesaving tax, forced savings, and investment. You guessed it—I’m talking about traditional life insurance policies.

Traditional insurance products such as endowment and money-back policies have for long escaped the cost scrutiny that most financial products are subjected to. These products, from LIC or private insurance companies, are sold with a strong emotional pitch, and people who buy it seldom think about what they are getting into. Rarely do they pay attention to what kind of cover they are getting, such is the single-minded focus on what they’ll get back at maturity.

Let’s take the case of most traditional products right from LIC’s endowment, money-back, Jeevan Anand, or traditional covers from private insurance companies. Do such products have costs? Most people think that, because no charges are mentioned, there must not be any. But sales commissions on these products are 35% in the first year, and 5% a year from second year on. And what about administration charges to pay LIC’s development officers, and mortality charges? These costs can only come out of your premium. So it means a debt product with such a cost structure is unimaginable.

On top of this, there’s an illustration given with a with 6% return and a 10% return. I cannot understand how a completely debt-based product with such a cost structure can deliver a 10% return. Just look at the bonuses declared by LIC in the last five years, and by most private insurance companies. Most bonuses are in the range of 3.2% to 5% (7% for whole life). Moreover, unlike PPF, returns from these policies are simple, not compounded. If these products are incapable of delivering 10% returns, their inclusion in illustrations makes no sense. It creates a false sense of hope that 10% returns are possible from such products.

There has been much talk about ULIPs (unit-linked insurance plans) and their costs. However, traditional products are also in need of a revamp and better disclosure. We are certainly not in favour of ULIPs, since we believe in keeping insurance and investments separate, and term insurance is the best way to do that. We maintain that insurance companies should reduce the cost structure of ULIPs. Several insurers are trying to do so. The same should apply to debtbased products, which can then potentially deliver decent returns. However, in their current avatar, these products are expensive.

So should one consider these traditional products at all? I don’t see how they can deliver even 8% returns. Of course, one can argue that the returns aren’t that bad when you factor in tax benefits. But chances are high that you’d be disappointed. At the most, you’ll get back a little more than what you paid. Except for certain high guaranteed return products, like Jeevan Shree (issued 2002), and plans such as Jeevan Aadhar and Jeevan Vishwas, I don’t see how other products can deliver superior returns.

Let’s take the case of LIC’s Jeevan Anand, which declared a bonus of Rs 34 to Rs 45 per Rs 1,000 in 2006-07—a return of 3.4% to 4.5%. For a premiumpaying term of up to 10 years, the bonus was Rs 34 per Rs 1,000, and for premium-paying terms of 20 years or more, the bonus was Rs 45 per Rs 1,000. LIC shares profits in the form of bonuses. Simple Reversionary Bonuses are declared per thousand of the sum assured at the end of each financial year. Note that there are no guaranteed bonuses in this policy. Consider the example for a sum assured of Rs 10 lakh for a 35-year-old male for a 20-year premium-paying term in which the premium is Rs 53,207 (see table). The returns work out to around 5.66%, including the final bonus.

When it comes to life insurance, one must first assess the amount of cover one needs. That is, of course, if one needs life insurance in the first place—if you’re single, have no dependents or liabilities, or have no charitable causes to support, there’s no reason to buy life insurance. Once you have calculated the amount of life insurance you must buy, your first choice should be a pure term plan. This will give you sizeable cover for a low cost, and will ensure you focus only on insurance, and get distracted by tax savings or investments. Of course, a term plan does come with tax benefits, so you can consider your overall cost of insurance lower on that account.
So, to sum up, just because no costs are mentioned in traditional plans, that does not mean there aren’t any. But if it’s a question of insurance cover, keep your focus on low-cost cover. When it comes to investments, be clear that high costs never enable a product to deliver high returns.

Amar Pandit is a Certified Financial Planner andDirector, My Financial Advisor

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