Insurance MIPs = high costs, poor returns

Insurance MIPs = high costs, poor returns

With uncertainty in the markets, investors are looking for avenues that can give them an assurance of certainty. And the insurance industry seems to be catering to this sentiment. With their focus already on traditional-cum-investment plans, life insurance companies are increasingly getting innovative. A recent innovation in the stable of traditional products is monthly income insurance policies.

These are basically money-back policies that ride high on the element of guarantee, which is appealing in the present market environment. Says V. Viswanand, director and head (products and persistency management), Max New York Life Insurance Co. Ltd: “We conducted a research in which a majority of customers preferred traditional endowment and money-back plans because what they give and get are clearly spelt out. Customers don’t understand the complicated features of a plan but can clearly understand the returns they get. Hence, they prefer products with guaranteed returns."

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These monthly income plans (MIPs) offer a guaranteed monthly income for a fixed number of years along with a non-guaranteed topping of bonuses. All this packaged with an insurance cover looks an attractive proposition. But look beneath the layer of a guarantee and you will find poor returns and high costs. Read on to know why these MIPs may not work for you.

How do they work?

Also See | What’s on offer (PDF)

What you get (PDF)

Max New York Life Insurance Co. Ltd’s Max New York Life Guaranteed Monthly Income Plan has tailored its additional benefit differently. Instead of bunching up the bonuses at the end, this plan has spread the additional benefits over and above the monthly income. Interestingly, the additional income is pegged to five-year government securities’ (G-secs) yields. This is how it works: The policy has two premium payment terms—six and 11 years. The premium that a policyholder pays gets pegged to G-sec rates to define the monthly top-up income during the payout stage. For instance, in case of an 11-year premium payment term, if in year two, the five-year G-sec yield is say 8%, then the policy will return an additional 53% of the monthly income in the first year of the payout term. Says Viswanand: “We have pegged the top-up benefit to G-sec rates to ensure transparency. Bonuses are at the discretion of the insurers and since the historical bonus rates or the performance of the funds are not readily available, it causes some uncertainty. By pegging the top-up monthly income to G-sec rates, a policyholder will know what his monthly income will be 10 years from now."

Star Union Dai-ichi Life Insurance Co. Ltd’s Defined Benefit Endowment Plan, however, has done away with bonuses. The plan returns a percentage of the sum assured at the end of the policy term as additional survival benefits.

The insurance element

Since these policies are primarily structured to provide a monthly income, the insurance component is not a lump sum benefit as is usually the case with insurance plans. These plans typically offer the guarantee of monthly income in the name of insurance.

For instance, Bharti AXA Life Insurance Co. Ltd’s Bharti AXA Life Monthly Income Plan pays all the accrued bonuses as lump sum and starts the monthly payout immediately for the beneficiary if the policyholder dies during the premium payment stage. Star Union Dai-ichi’s Defined Endowment Plan, however, offers a sum assured which is 180 times the monthly income that you choose. But on death only 25% of the sum assured is paid and the monthly income starts immediately.

So if you are looking to provide for a lump sum for your nominee, these plans won’t work for you. Says Viswanand, “The insurance element in these plans ensures that the monthly income is not interrupted in any way. MIPs are particularly good for customers in their late 40s because by the time they retire they will ensure a guaranteed monthly income."

The investment element

The guaranteed monthly income that MIPs provide are nothing to write home about. Sample this: A 30-year-old wanting a monthly income of 10,000 for a period of 15 years needs to pay a premium of about 90,432 for 15 years in Bharti AXA’s Monthly Income Plan. At the end of the premium payment term, the policyholder gets a monthly income of 10,000 for 15 years. This is a return of around 1.82%. However, if you build in the non-guaranteed benefits or the reversionary bonus, then assuming a gross return of 6%, your net return comes to 3.62%; on a 10% gross return, the net return comes to 6.45%. The two gross rates of return have been permitted by the regulator for illustrative purposes only. Here the cost works out to around 2.38-3.55 percentage points. And it is not the cost alone that hurts; the non-guaranteed bonuses are subject to the discretion of the insurer.

Max New York’s MIP works differently, but even here the cost hurts. In this plan, the non-guaranteed benefit which is a monthly income over and above the guaranteed income is pegged to G-sec rates as explained earlier in the story. Sample this: A 35-year-old buying this plan for an 11-year premium paying period for a monthly income of 5,000 for 10 years needs to pay 52,560 per year for 11 years. The return here works out to 1.71%. Assuming the average rate of the G-sec yields is 6%, the policy would return 4.15% and 7.22% if the assumed G-sec yield is 10%.

But the death benefit in this plan is much better than other plans. Upon the death of the policyholder during the premium payment term, the policy will pay back all the premiums paid till then as lump sum. The monthly income will start immediately and continues to pay the guaranteed monthly income till the end of the premium paying term. From the beginning of the payout period, the guaranteed monthly income for the specified term along with the additional payout commences. In the last year, it pays a terminal benefit equal to twice the annual premium.

What should you do?

For a young investor whose retirement is at least 20-30 years away, taking an MIP would make little sense. These plans come with a limited premium payment tenor and such investors may not need periodic income so soon. Their financial goals would be staggered over the years and their focus should be on wealth accumulation rather than periodic income in the not-so-far future.

However, these plans provide a solution to customers looking for products structured to save for retirement and to provide a guaranteed monthly income thereafter. But the trade off for this guarantee income is high costs and poor returns.

A better strategy would be to buy a pure term plan, the simplest and cheapest form of insurance, to provide a cover to your family during your working life. Simultaneously, you can save regularly to build a retirement nest egg. At the time of retirement, you could look at fixed-income products such as Senior Citizens’ Savings Scheme and fixed deposits to ensure a periodic flow of income. Says Pankaj Mathpal, a Mumbai-based financial planner: “Keep the two goals of accumulation and distribution separate. Look at equity products or long-term debt products such as the Public Provident Fund for the accumulation stage and structure your periodic income through fixed-income products."

MIPs are revamped money-back plans that offer customization at the cost of returns. Invest only if customization appeals to you.

Graphics by Sandeep Bhatnagar/Mint