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Business News/ Money / Personal-finance/  Assured returns on long-term plans
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Assured returns on long-term plans

Should long-term products also guarantee investment benefits upfront?

From (left to right): Nilesh Shah, R.M. Vishakha, Sumit Shukla, Amit GopalPremium
From (left to right): Nilesh Shah, R.M. Vishakha, Sumit Shukla, Amit Gopal

Life insurance companies offer many long-term products that also guarantee investment benefits upfront. But should long-term investment products offer guaranteed returns?

Nilesh Shah, MD, Kotak Mahindra Asset Management Co Ltd

Product manufacturers like mutual funds, insurance companies and pension companies should have the choice to offer guaranteed return products. The regulator must ensure that they are in a position to honour such guarantees.

The regulator must demand appropriate capital adequacy for providing guaranteed return to absorb market volatility. It should also prescribe the investment framework which supports the guaranteed return. The implicit guarantee of the sponsor, including the government, should not be taken into account for ascertaining guaranteed returns. It may be worthwhile to create a senior and junior structure across products like mutual funds, pensions and insurance; from a risk return trade-off perspective. The conservative investors can invest in a senior tranche, which increases safety and prefers returns near the guaranteed return level. The aggressive investors can invest in a junior tranche, where they take higher risks for higher returns. Market pricing will ensure appropriate segregation of risk and significantly reduce the need for capital, as well as improve the return potential.

The regulatory compliance for such product also will be fairly light compared to guaranteed-return products. It is time for market forces to create efficient solutions on products like guaranteed return rather than the current situation where investors bear disproportionate costs.

R.M. Vishakha, MD & CEO, IndiaFirst Life Insurance Co. Ltd

Guarantees in product are about transfer of risk. A market-linked product moves risk to the customer. A guaranteed product moves the risk to the company (shareholders). Long-term guarantees, with no option to adjust to market dynamics, are definitely not a good option since it is impossible for a shareholder to manage the unforeseeable risks of providing guarantees over the long term. However, guarantees structured with relevant market benchmarks, when well-administered and monitored, impose accountability and ownership to deliver to the customer a reasonable return. The suitability of guarantees is certainly based on financial literacy levels of customers along with the acumen and interest to devote time to financial management. It also has to do with the risk-return trade off that a customer is willing to make, on the basis of her age and requirements. Any guaranteed return product operates on excessive conservative mode of asset allocation and capital preservation, which runs the risk of non-maximisation of return. To give an example of trade-offs in financial terms, a spreadsheet calculation will prove that it is better to live in a rented house than buy your own house, considering all the factors of inflation and market volatility. There are still many people who buy a house to live in, because of the security of a ‘guaranteed’ roof over their head. Guarantees in products address this mindset.

Sumit Shukla, CEO, HDFC Pension Management Co. Ltd

While a guaranteed return on your investments is an enticing preposition, it has advantages and disadvantages. The biggest disadvantage is that individuals are generally locked into a relatively low rate of return, as compared to other investment products. Here, investors have to sacrifice the possibility of higher returns in exchange of guaranteed returns. Second disadvantage is that the investments are locked-in till the maturity of the product, so liquidity is very low. And the returns on these products may not keep pace with inflation. Typically, there are two types of costs of guarantee for customers. One is the cost of providing the guarantee by the service provider, which is charged to the funds. Second is that the investments are made in relatively higher safety but low yielding assets, which reduces the returns on investments for the customers. Together, they make the product less attractive for a long-term investment. Ideally, long-term investment products like insurance and pension should not offer guarantees. But considering the spectrum of customers with varying risk profiles, it makes sense to keep these products in the basket of products. Customers with relatively conservative approaches and risk profiles can choose them. Even those close to retirement (1-3 years) or retirees looking to invest their retirement corpus, who want certainty of capital not getting eroded, can look at such products.

Amit Gopal, senior vice-president, India Life Capital Pvt. Ltd

Last year, we entered a regime of lowering interest rates, but for my father this meant a sizeable cut in the rates on his fixed deposits—his sole savings. It also changed my perspective on the need for guarantees and fixed-return products. For long, guarantees were akin to subsidies for me: expensive, inefficient and fraught with moral risks. But I realise the need for them despite these ills. Long-term savings instruments like pensions need elements of guarantees. Specially in a heterogeneous population like India, where pensions mean different things to different people. The need for guarantees is driven by poor financial literacy, over-regulated and under-supervised financial markets and most importantly, evolving asset allocation in such products. In the past, the underlying assets of these instruments were largely government securities, for example: EPFO’s fund and LIC’s investments. This is changing with equities and alternate asset classes creeping into the asset allocation. Till one sees a stabilisation of this transition, the risk of failure or underperformance cannot be incident on the investor. Guarantees will come with costs. Every stakeholder should share the burden— the investment community (which needs to develop this market), beneficiaries (who need such guarantees) and the government (which wants a pension society). Doing away with guarantees completely is bad economics.

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Published: 17 Apr 2017, 05:05 PM IST
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