The insurance regulator (IRDA) has come out with lot of regulations in the life insurance sector in the last 2 years. As per the latest modifications, there are lots of restrictions in a ULIP policy, which makes these policies more beneficial to the customer. But is it enough to protect the majority of the customers, who are buying these policies mainly for tax savings and long term savings? Still, there exists lot of loopholes to attract customers with hidden agenda.
As you are aware SEBI is not allowing Mutual funds to offer any guarantee on returns to the customer. IRDA has allowed the insurance companies to show projections regarding returns at 6% and 10% for better understanding of the customer. But for the last 2 years, we are seeing lot of policies with the concept of highest NAV guaranteed. Let us analyse this concept in detail.
How this policy guarantee NAV?
NAV is the short form for Net Asset Value, a common term used by mutual Fund industry to denote the value of one unit. The highest NAV guarantee concept works on the principle of Constant Proportion portfolio Insurance (CPPI). These policies give enough freedom to the fund manager to invest your premium in equities, debt or money market instruments in varying proportion between 0 to 100%. Don’t get Confused .I will make it simple.
Suppose a policy starts today and is guaranteed to give highest NAV in the 7 year term. Let us see how we can control the investment between debt and equity to offer guaranteed NAV on maturity.
In the beginning, let’s assume a NAV of Rs 10, and the asset allocation in the first year is equity-100% and Debt-0%.Suppose, the market moves up and NAV goes upto Rs 13 by the end of the first year. At this point, the Insurance Company has to provide for at least Rs 13 as the return after 6 years. Now in order to achieve this, all they have to do is keep X amount in debt instruments which will mature in next 6 years and provide Rs 13 at the end of 6 yrs, so assuming the debt return at 8%, they need to put around Rs 8.20 in debt, so that the maturity of this will be Rs 13 at the end of 6 yrs.
They can now invest Rs.4.8 in equity after investing 8.2 in debt, because whatever may happen to the equity, the maturity value of 13 can be guaranteed from the debt investment itself. If the market goes down, the NAV will go down, but the debt investment will ensure the payment of 13. If the market goes up, and if the NAV becomes say Rs.16, then they will again move money from equity to debt to ensure the value of 16 on maturity. The major drawback of this strategy is that the fund manager cannot take the risk of shifting money from debt to equity to benefit from any change in equity market. This will ensure that the NAV is guaranteed on maturity, but the investment in equity will reduce fast and debt increases.
What returns you can expect?
As you are aware the long term returns from equity is in the range of 12-15% and that from debt investments will be in the range of 6-8%. In this concept, we will get a small exposure to equity while major portion will be in debt after some time, which will limit the return. We can expect a return of around 8-10%. On the long term, a normal ULIP can give better returns than these policies. This concept is ideal for those, who are very conservative or can be considered as part of your debt portfolio.
If you are looking for modest returns, like 8-10%, you can invest in these policies. The return of these policies may be high in the beginning, if market does well, but when market starts performing badly, the returns can take a hit. Your NAV will be protected for sure, but the returns won’t be, since over time the CAGR return will go down. PPF will be a better option because of its flexibility and tax free status on maturity.
How much the Company will take as Charges from your premium?
So far, I have not mentioned anything about the costs attached with these plans. In one of the most popular policy now available in the market, the total premium allocation charges are 24% in the 5 year premium payment period. This works out to be an average of 4.8% per annum! (Please remember that, we have good mutual funds with no entry charges). Then there is an administration charge of Rs.30/- per month which increases by 3% every year and is chargeable for the entire term of 10 years! Then the fund management charge is 1.3% pa, including the guarantee charges. Also you will have to pay for mortality charges for insurance, as per your age and sum insured. All these charges can bring down your returns.
Some of the agents are selling these as ULIPs which will offer equity returns and they are projecting the returns based on equity return for the total term!
The popular policies in this series are Pinnacle from ICICI Prudential, Samridhi Plus from LIC, Platinum Advantage from Birla Sun life and Smart Performer from SBI Life.
So, even when the NAV is guaranteed, there is no guarantee for the return for your investment.