Negative returns in the garb of guarantees

Continuing with the trend in recent times, two more insurers have come up with plans offering guarantees. These plans can also double up as pension products since they offer a guaranteed payout over the long term. Tata AIA Life Insurance Co. Ltd launched MahaLife Supreme Endowment Insurance Plan, an insurance-cum-investment product that guarantees a periodic income along with the maturity benefit in the end. SBI Life Insurance Co. Ltd launched Smart Income Protect that offers non-guaranteed maturity benefits but guaranteed regular cash flow after the premium paying term ends.

Mint Money puts the two plans to the test of returns and insurance cover.

MahaLife Supreme

This is a non-participating plan that guarantees returns upfront. The sum assured is a flat 10 times the annual premium you choose to pay and the guarantees are pegged to the sum assured. The death benefit during the policy term under this policy is the higher of the sum assured, or policy term multiplied by half the annual premium or 105% of premiums paid till date if you are below 45 years of age.

The plan offers two policy terms: 30 and 35 years. The term you choose will decide the number of years you will need to pay the premiums and the number of years you will get a guaranteed payout, besides the guaranteed payout.

For a 35-year term, you will pay the premium for 15 years and get a guaranteed annual payout for 20 years. Over a 30-year term, you pay premiums for 12 years and get a guaranteed payout for the next 18 years. At the end of the term along with the last instalment of the annual payout you get a lump sum maturity benefit.

What is the guaranteed payout? It is a percentage of the sum assured and ranges between 6% and 10.4%, depending on the premium you choose and the policy term. The higher the premium and the term, the higher is the guaranteed payout. The maturity benefit ranges between 115% and 138% of the sum assured. The older you are, the lesser you get.

Investment returns: The brochure of MahaLife illustrates the benefits with an example. If a 35-year-old pays an annual premium of ₹ 50,000 for 15 years, his sum assured will be ₹ 5 lakh and the annual payout would be 10.40% of the sum assured. This means after paying ₹ 50,000 for 15 years he will get ₹ 52,000 from the 16th year for the next 20 years. At the end of the 20th payout year, he will also be entitled to a maturity benefit that is 136.50% of the sum assured or ₹ 6.83 lakh. The death benefit in this case would be ₹ 8.75 lakh.

A simple internal rate of return calculation shows that your return on investment is just 4%. In other words you are locking into a 4% return rate at a time the country is witnessing a high interest rates. “This product guarantees returns over a long period of time. Guaranteed return can never be more than the market rates. Just like you have savings account, this plan is like an insurance account where your money earns a rate of interest, although here it is tax-free and you get a life cover,” says Vijay Sinha, senior vice-president, agency sales training, product development and marketing, Tata AIA Life.

Should you lock in? “No. There is a huge disconnect between the market rates and what this product offers. For a guarantee, a customer ends up paying a huge price. There are long-term bonds that give a return of around 8%, so clearly the interest rates will not drop drastically in the years to come. Even if they do I would recommend customers to buy into the current interest rate so that they are able to earn more due to the power of compounding,” says Suresh Sadagopan, Mumbai-based financial planner.

Consider a Public Provident Fund (PPF) that is currently offering a rate of 8.8% and enjoys the same tax benefits as insurance products. Assuming a flat rate of 8%, ₹ 50,000 invested today for 15 years will return ₹ 13.58 lakh at the end of 15 years. You can invest this money to buy a fixed-income instrument but even assuming a zero rate of return on the fixed income instrument, you would still get an annual payout of ₹ 67,880, about ₹ 15,880 more than MahaLife payout.

Smart Income Protect

It is a participating plan; the return on investment would depend on the bonus that you get every year. The annual payout is guaranteed under this plan.

Under this plan, you need to pay a premium every year for a specified term. The premium will depend on the sum assured you choose. Taking the example from the brochure, if you are a 35-year-old and choose a tenor of 15 years and sum assured of ₹ 10 lakh, you will need to pay an annual premium of ₹ 76,270. After you pay the last premium in the 15th year, the payout period starts. So in the 16th year, you will get a lump sum that will depend on the bonuses that the insurer has paid so far and you will also get a guaranteed annual income that is equal to 11% of the basic sum assured. Here, you will get an annual income of ₹ 1.1 lakh for the next 15 years. In case of death in the premium paying term, the policy returns the sum assured plus the bonuses to the beneficiary. In case of death during the payout stage all future payouts are paid in lumpsum.

Investment returns: Before we estimate a return from the policy, factoring in the bonuses, let’s examine the guaranteed returns of this plan. In the above example, ₹ 76,270 paid in the first 15 years and ₹ 1.1 lakh received in the next 15 translates into a return of about 2%. Let’s pull in the bonuses. At an assumed rate of 6%, the policyholder in the above example will get a maturity bonus of about ₹ 3.37 lakh or a net return of 4%. At an assumed rate of 10%, he will get a maturity bonus of ₹ 6 lakh or a net return of about 5%. Since the returns are not guaranteed, we looked at the net return or costs in the plans.

Should you lock in? Going by the net returns, this plan is very expensive and since it offers very little guarantee, you should consider PPF instead. “One should look at asset allocation. If you have a long-term horizon, then I would recommend exposure in equities,” says Sadagopan.

Mint Money take

The insurance cover under both the plans is very expensive. For protection needs, what you need is a pure term plan, whose online versions come cheaper. Coming to guaranteed payouts, it appeal to risk-averse investors, but you should understand that such guarantees translate into a negative real rate of return, when you factor in inflation.