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Business News/ Opinion / 8% of sum assured is not a great return on investment
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8% of sum assured is not a great return on investment

It's important insurers disclose the effective return on investment in guaranteed income plans

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

The product brochure of a private life insurer is very attractive at first glance. A bright maroon tick mark certification promises guaranteed income. A few lines below, it promises to pay 8%—in bold text—of the annual sum assured in monthly instalments.

With only the figure highlighted, the plan is likely to get misinterpreted. There’s a good chance that the sum assured bit will stump you, but what will attract your attention is the 8% income highlighted in bright blue text. You may mistake that to mean the return on investment. Understandable, after all isn’t that what we look for in financial products that guarantee returns?

Returns are easier to grasp in straightforward products such as fixed deposits, Employee’s Provident Fund (EPF) or Public Provident Fund (PPF). 100 becomes 108 and then compounds to 116.4 at a rate of return of 8% per annum.

But how do you process returns when there is no straightforward link between the rate of return and the amount invested? That attractive brochure does not offer an 8% return on investment; it simply agrees to an annual payout—in monthly instalments—of 8% of the sum assured, along with other lump sum payments on maturity. But what is the rate of return here? Very few of us will notice the twist. The savvy ones will run the numbers to calculate the effective return on investment, but for the majority the numbers will be confusing. The brain sees the 8% figure and takes it to mean the return on investment.

This brochure is just an example of how insurers are preying on this mindset. The actual return on investment in this case is around 4% and this is not the only instance. Pick up the literature of any insurance policy that guarantees investment benefits and there is a good chance you will come out completely confused about investment returns from the policy.

In most cases it will be around 4%, but the brochure will showcase comebacks at 8% of the sum assured, 13% of the sum assured or 150% of the annual premium. So, while you see seemingly attractive payback, it’s difficult to get a sense of the actual return on investment. These plans will usually not tell you the effective rate, not even in the fine print. They don’t because they are not mandated to do so.

In industry parlance guaranteed insurance products—where investment benefits are guaranteed upfront—are known as non-participating plans. They are non-participating because the investment benefits in these plans are not linked to the performance of the underlying fund. Regulations require investment benefits to be guaranteed upfront and the benefits are illustrated in the form of cash flows. But what insurers do is follow the regulations to the letter. Ideally, they should also do so in spirit and disclose the return on investment. Return on investment is a handy tool that helps you compare financial products. In fact, when reviewing an insurance policy that’s the first thing I look at.

Guaranteed plans are here to stay, what with their obvious appeal—it’s much easier to sell a plan that guarantees investments. Insurers benefit since they can retain the entire profit from the underlying fund. Obviously, if the portfolio makes a loss you are shielded and the insurer takes a hit.

But the current batch of guaranteed insurance plans are set to undo what product regulations have been aiming to do: align the interests of all the parties involved and make insurance products transparent and easy to understand.

Going back to the highlighted 8% in the brochure, what purpose does it serve? Is payout at 8% of the sum assured attractive? No, if you calculate the effective rate of return that works out to 4%, and certainly not if you look at other products such as the good old PPF, which currently gives a return of over 8%. The highlight is merely to get you to notice the plan, but it should also disclose the effective return on investment. There should be a standard format to disclose the effective return in these plans.

For insurers this will be easy, as they know the amount they guarantee. For customers, it’s a step towards transparency and it enables product comparison. Products that guarantee returns over the long term tend to be conservative. This means you are bringing home sub-optimal returns that could destroy the value of your investments. Over a period of time, your money will buy you less than what it’s capable of buying currently due to inflation.

Yet there will be investors who want to settle for guarantees and trade-off returns, but their decision should be rooted in the knowledge of the actual returns and not in confusing returns showcased by these plans. A well regulated product needs to ensure the customer walks in with her eyes open. And for that it’s important insurers disclose the effective return on investment in these plans.

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Published: 27 Nov 2013, 07:02 PM IST
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