Return on sum assured is different from annual return

Life insurance companies are launching guaranteed income insurance products

 

Life insurance companies are launching guaranteed income insurance products. But do these schemes really deliver the promised income? Monika Halan, editor, Mint Money, and Vivek Law, editor, Bloomberg TV India, examine if these products indeed deliver the promised returns. Here are edited excerpts from their show, Smart Money:

 

Vivek: We recently saw a whole range of net asset value (NAV) guaranteed schemes. Is there really a guarantee?

Monika: There are two kinds of insurance products—market-linked products called unit-linked insurance plans (Ulips), and then there are the traditional plans. When the Ulip rules were changed in 2010, commissions came down and these are now comparable with mutual funds. The traditional products still give an upfront commission in the first year from your premium of up to 40% for products which has premium paying term of 12 years or more.

So 40% of your money still goes as commission and guaranteed income plan is part of this traditional product basket. What is it that they are guaranteeing? The brochures of these products say 8%. Keep in mind that this is 8% of the sum assured, which is very different from an 8% return. When you do the math, what is your actual rate of return? It is actually no more than 4% for most of these plans. So I feel, the 8% or 9% or 11% is misleading to investors in a certain way because in their head investors are thinking returns but the brochure clearly says sum assured 8%.

I don’t know how many investors understand this nuanced difference between a sum assured and a guaranteed rate of return but I feel that they should just ask the person selling what is the annual rate of return. Because clearly the rate of return is not 13% or 8%, it is much lower.

Vivek: Now we have Kavita Singh joining us from Bangalore.

Kavita: I work for a multinational company in Bangalore. I need your advice on two key matters. Firstly, I want to change my insurance plans and I need some advice on which insurance plan should I take that will give me good risk cover and at the same time it should be flexible in terms of withdrawal amount. Secondly, I will be retiring in the next 15 years. I want to maintain a good lifestyle and not be financially dependent on my son.

Monika: Your money box talks about the stress and pressure of a single income, no alimony support and a medical event which really eroded your money box. So, what do I see in the money box? There is a single high income. There is a dependent son who will start earning in the next five years. You have your own house. There is some money in your provident fund (PF) and Public Provident Fund (PPF). Rest of the money box is practically empty. First, I want you to build your emergency fund. You already have a fixed deposit (FD). And as you rightly want to surrender your high-cost low-return insurance policy, the surrender amount that you get back can be clubbed with your FD and you have your emergency fund in place. That is your money with six months’ living cost. Now lets come to your insurances. My first concern is about your medical insurance policy. There is a cover from your office but we need to build a cover for you and your son which you own. In the next 30 days you should get a Rs.5 lakh (each) medical cover for you and your son. Top it up with a Rs.15 lakh family floater cover. So individually you will each have a Rs.20 lakh cover and that should not cost you more than Rs.25,000-30,000 a year. Now you need a life cover till the time your son begins to earn. A Rs.1 crore cover is enough for you at this stage. It will cost you about Rs.15,000 a year. The minute your son gets financially independent you stop that insurance as then you will not need a life cover at all. The third part is your investments. The first thing I want you to do is to hike your monthly surplus to Rs.50,000. Create three accounts—there is a salary account into which all income goes, you push part of it into your monthly living costs. I call it the ‘spend it’ account and that’s all the money that you will spend in that month. Then there is an ‘invest it’ account. The rest of the money sits in that account. The good thing is a lot of your big goals are over. You will have certain shot-term needs like you said Diwali shopping and traveling. Since, these are short-term goals don’t use equity-linked products for that. Stay with products you understand such as an FD. So you are putting 20% of you total investment money into short- and medium-term goals. And 80% of you savings you are putting away for your retirement. The core of your portfolio remains your PF. Let’s keep this money going safely for the rest of the 15 years of your career. Credit your PPF account with Rs.1 lakh every year. I would encourage you to understand mutual fund products. I would recommend two balanced funds and two large-cap funds.

The fourth area is to create a will. Since there has been a situation of separation in the family, you must be sure that the assets your have created go to your son. Create a simple will.

Write to mintmoney@livemint.com OR sms at 9773270010. Type SM, give a space, and write your query.

Catch the show on Friday: 08:30pm, Saturday: 06:00pm, 08:30pm, Sunday: 10:00am, 12:30pm and 05:30pm on Bloomberg TV India.  

 

 

TOUHID HUSSAIN

PGDM 2nd YEAR