Sure, and life insurance is about budgeting for a Plan B, just in case your life doesn’t go the way you planned it. It’s about asking yourself uncomfortably morbid ‘what if’ questions. As in: what if I, in the immortal words of obituary writers, die ‘an untimely death’? Will my dreams for my family—that sea-facing apartment in Worli, that aeronautical engineering degree that my daughter aspires for—too die with me? Or can I bequeath them a financial legacy that will let these dreams come true even if I’m not around?
These and other considerations have prompted Manoj Kohli, 44, joint president (mobility), Airtel, to take on a string of policies from Life Insurance Corporation (LIC), right from when he was 20, on which he pays a collective premium of Rs 36 lakh a year! Kohli views insurance as both risk protection and investment: he is covered for about five times his annual salary, which he considers adequate, and will get guaranteed returns of about 9 per cent a year. "Given the many uncertainties we face today, I need the anchor of insurance," he says. Most of his insurance investments are in LIC fixed-return plans that will mature over 10 years, from the time he is 55. Since he’s a high-income earner, Kohli gets no tax rebate on his premiums. He reckons he doesn’t need any more insurance.
While saving and investing for life’s financial goals, each of us opts for investment vehicles that suit our specific needs, based on our projections of what returns they offer and our understanding of how risky they are. Countless passive investors choose ‘endowment plans’: plans that, in addition to providing life cover, also serve as savings-cum-investment vehicles and offer tax-free returns. The returns come either during the term of the policy (in ‘money back’ variants of endowment plans) and/or at the end of the tenure—or on death.
Endowment plans aren’t the cheapest life insurance options going. The premiums you pay on them are substantially higher than on frills-free ‘term plans’, which provide life cover but offer no returns if you survive the policy. So, endowment plans are hugely popular investment vehicles. But very few of those who invest in them understand whether the returns from them do justice to the higher premiums.
Consider the case of a 30-year-old who wishes to buy a Rs 5-lakh insurance cover for 20 years. An investment in New Jeevan Shree, now the only endowment plan offering guaranteed returns, paying a premium of Rs 43,600 a year for 12 years (the premium payment period for such a plan), yields total returns of Rs 12 lakh, tax-free, and effective returns of 5.76 per cent. Or, he could go for a term plan for the same tenure and sum assured at a far lower premium of about Rs 1,500 a year for 20 years, and invest the premium differential (about Rs 42,000 a year for 12 years) in instruments of his choice. Here’s how his investments will fare:
- An instrument offering 8 per cent compounded annually (which the PPF does even after its interest rate was lowered in Budget 2003) will return Rs 16 lakh after 20 years; even at 7 per cent, it will return Rs 13.8 lakh.
- An equity fund that offers a return of even 10 per cent will yield Rs 21.2 lakh.
The same argument holds even if one considers endowment plans that offer annual ‘bonuses’, not ‘guaranteed additions’. Insurers declare bonuses from out of the profits they generate, and therefore there is no guarantee on how much you will pay out each year. Consequently, the premiums on bonus-linked endowment plans are substantially lower than on those that offer guaranteed additions—but still far more than on term plans.
Indicatively, on a 20-year endowment plan with a sum assured of Rs 5 lakh, a 30-year-old pays a premium of about Rs 24,000 a year for 20 years. Assuming a bonus rate of Rs 50 per Rs 1,000 sum assured (against the current bonus rate of Rs 65 per Rs 1,000), he’ll get Rs 10 lakh when the policy matures; the effective returns in this case work out to 6.6 per cent. Alternatively, if he bought a term plan for Rs 1,500 a year and invested the surplus (about Rs 22,500 a year for 20 years), he’ll get Rs 11.1 lakh from the PPF (at 8 per cent) and Rs 14.1 lakh from an equity fund (at 10 per cent).
"Endowment plans aren’t attractive investment vehicles," says Delhi-based risk management consultant Swami Saran Sharma. "The premium you pay on them is divided three-way—risk protection, management fees and agency charges, and investment. After providing for the first two heads, only about 70 per cent of your premium is invested on your behalf."
But insurers claim that this argument makes one crucial assumption: that a person who takes responsibility for his investments is disciplined and equipped to make the right decisions. Says Nani Jhaveri, ceo of Birla Sun Life Insurance, "Financially savvy, disciplined investors may be able to manage their investments, but these attributes are hard to find." MetLife India MD Venkatesh S. Mysore notes: "In fact, very few individuals who take charge of their investments have translated intentions into action: this is reflected in the low investment and savings balances of people we meet. It’s in this context that insurance plans offer a disciplined way of saving."
Investments in insurance products enjoyed a fairly distinctive tax edge but that’s already been somewhat blunted. Under Section 10(10D) of the I-T Act, maturity benefits on insurance plan are entirely tax-free in your hands. Additionally, premiums paid on pension plans offered by insurers qualify for a deduction of up to Rs 10,000 under Section 80CCC. And for those with a taxable income less than Rs 5 lakh, investments in life insurance products qualify for a rebate as applicable under Section 88. But given the government’s commitment to move away from an exemption-based tax system as articulated by the Kelkar Committee on direct tax reforms, these breaks are certain to be whittled down over a few years.
After Budget 2003, for instance, insurance plans in which the premium exceeds 20 per cent of the sum assured will not qualify for Section 88 rebate; additionally, the maturity benefit will be subject to tax. This makes single-premium plans—which work like cumulative deposits with a life cover—less tax-efficient than they were. LIC’s popular New Bima Nivesh, ICICI Prudential’s LifeLink and hdfc Standard’s Single Premium plan have, at one stroke, become less attractive to investors.
Given all this, it might be imprudent to base an investment decision solely on the basis of the tax edge that insurance products currently enjoy. The test of whether endowment plans make good investments, thus, hinges on a reasonably accurate projection of the returns they offer. That’s easier said, given the impossibility of predicting interest rates, inflation rates and tax rates over 20 years or more—tenures typical of insurance contracts.
LIC is the sole insurer to offer a ‘guaranteed addition’ endowment plan; guaranteed additions, expressed as a certain sum per Rs 1,000 sum assured per year, are payable on maturity. In the era of high interest rates, LIC marketed several assured returns schemes, but in recent years, these have proved unsustainable as they offer lower effective returns than other plans.
A few other endowment plans are bonus-driven. Bonuses, declared as a certain sum per Rs 1,000 sum assured, are paid out from the profits that the company makes each year. LIC’s bonus record tells quite a story—and points to the road ahead as well as the uncertainty in projecting returns from endowment policies. After rising steadily for decades, LIC’s bonus rates have levelled off; in fact, over the past two years, they’ve been dipping. So, when you’re projecting returns on bonus-linked plans, you’re taking a call on bonus payouts over 20 years or so. That long shot is the uncertainty that defines these returns, just as fixed-income investments like PPF are susceptible to interest rate uncertainty, and mutual funds to market uncertainty.
Additionally, in the two years and more that they’ve been around, private insurers have changed the manner in which bonuses will be declared and given investors the option to receive them during the policy tenure. But this has meant that comparing the returns on endowment plans across insurers has become rather more complex.
Therefore, if projecting returns on bonus-based plans seems daunting, it’s understandable. But even if you work within a band, and work out several ‘what if’ scenarios, you’ll broadly know what to expect from endowment plans.
Budget Impact
LIC to launch a new scheme with guaranteed returns for senior citizens
All powerloom workers to get a special cover against death and disability
Public sector firms to design community-based health schemes in 2003-04
Centre to pay part of the premium for the above to make them affordable to the poor
An additional 50 lakh BPL families to be covered under the schemes in 2003-04
V. Venkatesan with Gauri Bhatia
