It is difficult to resist an insurance policy that pays around Rs52 lakh on an annual investment of Rs1 lakh for 20 years. This is assuming a growth rate of 10% each year; the Insurance and Regulatory Development Authority (Irda) allows agents to show growth at 6% and 10%.
So when the agent points out at this figure in the benefit illustration of the policy, you tend to think your policy will actually match the return mentioned. What you may not realise is that these are just assumed rates of growth and only for illustrative purposes.
This has become a matter for concern for the regulator, which is considering altering the rates to make the illustrations more conservative. In fact, as a step towards putting this theory in practice, the new guidelines on pension plans issued on 8 November have reduced the illustration rates to 4% and 8%.
Says J. Hari Narayan, chairman, Irda: “The rates used for illustrative purposes are pitched too high and the fear is that these projected returns when seen on a piece of paper may cause some sort of an illusion in the minds of the customers, who will believe the assumed rates as the real return of the policy. Therefore, the rates of return need to be a little conservative.”
File photo of IRDA chairman, J HariNarayan. Photo by Bharath Sai.
The regulator’s concerns are not unfounded. While in unit-linked insurance plans (Ulips), a 10% assumed rate of return may still hold water, considering that over period above 10 years equities are capable of returning at least 10-12%, it is too high a number for traditional plans that invest mainly in debt products.
Why do you need an illustration?
The illustrations help a customer understand a policy better. Basically, a benefit illustration is a year-by-year summary of costs and benefits and how costs will affect the growth of your fund. While costs are known in the policy, one needs to assume a rate of return in order to show the implication of these costs on the returns. To provide a solution, the regulator allowed two rates: 6% on the conservative side and 10% on the aggressive side.
In the example mentioned above, a sum of around Rs52 lakh means a return of 8.41%. A net yield of 8.41% on an assumed rate of 10% means the cost impacts the return of the policy by 1.59 percentage points.
Chances are that the actual impact of cost may get buried under the hefty sum of Rs52 lakh that a projected rate of 10% offers. Says Narayan: “Projections on paper have a greater authority and a customer starts expecting the same returns that he sees on paper. That is digressing from the purpose of an illustration which is to indicate the costs and benefits of a policy to the customer. By having a conservative rate, the customers’ expectations will not be unrealistic and the focus will be on the main purpose of the policy.”
But the insurers argue that in case of Ulips, which invest up to 100% in equities, a 10% return may not be too euphoric. Says Puneet Nanda, executive director, ICICI Prudential Life Insurance Co. Ltd: “For Ulips that invest largely in equities, a return of 10% over a long term is achievable. However, if Ulips are investing in fixed-income instruments, then a 6% rate should hold good.”
However, in case of traditional plans that invest largely in debt products, the projection of 10% may be unrealistic. Agrees Kamalji Sahay, CEO, Star Union Dai-ichi Life Insurance Co. Ltd: “Traditional plans offer moderate to conservative returns. In the last 15 years, the returns have been an average of 5%, including bonuses. Hence, if the illustration shows an yield on an assumed rate of 10%, it is not only unrealistic but will also lead a customer to believe that the policy is capable of such returns. In the case of traditional plans, 4% on the conservative side and 8% on the aggressive side should be good.”
The proposed solution
The regulator is still deliberating upon the new illustration rates to be taken for illustrative purposes in life insurance policies. According to the regulator, it may clip the 10% assumed rate to around 7-8%.
However, any changes in this regard will come through only next year. Says Narayan: “This is the wrong time of the year to introduce any changes since insurers do a lot of business in this quarter and the next quarter. Any change will come through only after April or May.”
The regulator is increasingly looking at ways to make insurance policies user friendly, but in order to get the best out of a policy illustration, look at these things: the impact of costs on your return in the case of Ulips and the guaranteed payout in the case of traditional plans.