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Guaranteed Return Insurance Policies - Yields are very low
The yields of life insurance policies that offer guaranteed returns are very low.
Investors should consider other comparable products before pouring money into these plans.
Here's an attractive offer. Invest Rs 69,675 per year for 10 years and get back a guaranteed tax-free corpus of Rs 14 lakh after 20 years. The HDFC Sanchay insurance policy from HDFC Life will not only double your investment of about Rs 6.97 lakh, but also provide life insurance cover to you. If something unfortunate were to happen to you during the term of the policy, your nominee would get the higher of the following: sum assured of Rs 6.97 lakh or 105% of the premium paid till then, along with guaranteed additions that may have accrued.
Sounds great? Not really.
The policy offers a return of only 4.6% on the investment. We calculated and found that if the investor (in this case, a 35-year-old female) buys a term insurance cover of Rs 25 lakh and puts the balance in the PPF, she would have a corpus of about Rs 25 lakh in 20 years. The only glitch in this calculation is that there is no assurance that the PPF will continue to give 8.75% return for the next 20 years. The benchmark government bond yields have fallen by almost 50 basis points in the past few months and analysts expect them to fall below 8% in the coming months. The returns offered by small savings instruments like the PPF and NSCs are linked to the yields of government bonds of similar maturity.
On the other hand, the non-participating endowment insurance plans from insurance companies offer assured pay outs. Several such plans have been launched this year after the Insurance Regulatory and Development Authority (Irda) introduced sweeping changes in traditional plans in January. Indians love assured returns. According to the RBI data, fixed deposits account for roughly 56% of the total financial assets of Indian households, while stocks and mutual funds make up just 5.2%. Participating endowment plans have a variable component in the form of annual or terminal bonuses. These bonuses range from 4% to 6% depending on how the investments made by the insurance company have performed. In non-participating plans, there is no variable component and the entire maturity benefit is declared upfront. In such policies, the entire amount available on maturity (or as periodic survival benefits) as well as the death benefit is guaranteed. This must surely appeal to investors looking for certainty. Most financial planners frown upon products that mix insurance and investment. They would rather have each handled separately. Besides, any product that offers guaranteed returns will have to adopt a conservative investment approach. The moment a guarantee is offered, the product's ability to generate returns is severely curtailed. Moreover, high charges in insurance-cum-investment policies eat into the returns. It is hardly a surprise that the returns of some non-participating endowment plans are even lower than those from a savings bank deposit
Even participating plans do not offer attractive returns, but at least there is scope for slightly higher returns in the form of bonus, which is not the case with guaranteed plans where the returns are predetermined. Since they have to give a guaranteed return, the corpuses of non-participating policies are invested in low-yield but ultra-safe instruments. Since these products offer guaranteed returns, the insurance company may act conservative and offer lower returns compared to participating policies.
Right now, the big challenge before insurance companies is the decline in interest rates. While an investor in a traditional participating endowment plan will have to bear the risk of softening rates, here the risk of interest rate movements is borne by the insurance company. The IRDA has also expressed concern over the ability of life insurers to offer `good' returns in a falling interest rate scenario.
When interest rates are softening, returns of such non-participating savings products are impacted. However, the returns guaranteed to the customer do not change.
Such policies may appeal to some investors because of the tax-free corpus and guaranteed returns they offer. However, they should consider other investment avenues. It's best to keep your investment and insurance needs separate. You can look at other, more remunerative investments and equally secure avenues to plan for long term goals and buy a simple term cover to meet your insurance requirements.
For instance, if you are looking for secure returns and tax free corpus, you can consider the PPF or tax-free bonds. Our calculations show that the maturity value of a combination of a term plan and PPF will not only give you a significantly higher cover but also churn out better returns. What's more, an insurance policy forces the investor to make a multi-year commitment, while the PPF is a flexible investment. You are required to invest a minimum of `500 in a year. If you miss that, there is a small penalty of `50 per year. However, if you are unable to pay the insurance premium for 2-3 years, the policy may lapse.
Investors can also consider the tax-free bonds available in the secondary debt market. The prices of these bonds have rallied in recent months, but the yields are better than those offered by these guaranteed return policies.
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