Guaranteed Life insurance plans are the basic product offered by almost all insurance companies. These plans attract a wide customer base especially during the last few months of the tax saving season. Also, in a state of falling interest rates, such guarantees attract those individuals who want life insurance for availing tax benefits.
In these plans, Insurers declare a ‘guaranteed addition’ (GA) or ‘guaranteed return’ instead of bonus which varies depending upon the profits made by the insurer. Apparently, such plans appear attractive with lots of guarantees thrown in at different stages of the policy. All in all, the maturity amount is guaranteed and so are the monthly payouts.
Such plans may come up with the offers of guaranteed addition of 7-9 per cent of premium per annum or guaranteed payouts of 126-138 percent of the annual premium each year.
The gap between guaranteed and actual returns
The guaranteed addition is not equivalent to the actual annualized returns. These guaranteed benefits accrue only on maturity and hence the actual return will vary from the one which is guaranteed to the customer. Guarantee always comes at a cost, therefore, the returns, after adjusting for the costs because of the guarantee, are low in such plans.
Although actual returns would depend on one’s age, term and premium amount, the average IRR (internal rate of return) in most traditional plans, including money-back, endowments, lie between 2 to 6 per cent per annum. The plans with guarantees would carry even lower returns.
Let’s assume that there’s a guaranteed plan for a 10-year term, but with a premium paying eight-year term. The plan offers guaranteed payout of 150 percent of premium every year after maturity of 8 years.
It means that the premium is to be paid for 8 years, but life cover will run for 10 years. After maturity, payouts will happen for the next 8 years. Illustratively, if the premium is Rs 20,000, it has to be paid for the initial 8 years. Thereafter, from 10th till the 17th year, there will be an annual payout of Rs 30,000. The IRR in the above plan comes to 2.9 per cent per annum!
Types of guarantees
The structure of the guaranteed plans is not the same across insurers.
- Insurers may offer a guaranteed return based either on the premium or on the sum assured.
- The guarantee may also differ based on the term of the policy or even the premium paying term.
- In some plans, the guaranteed returns get added to the policy from the second year onwards, while in some, it may start at a later date.
- Some of these plans are similar to money-back plans wherein there is a regular flow of income at regular intervals, while in some, there could be a lump sum payment on maturity.
- Further, in a few of them, payouts happen after maturity for a certain number of years.
Guaranteed traditional plans gets complex
The offering could be anything, but hidden beneath the complex workings of insurance plans is the payout structure. There has been a vast change in the traditional life insurance which earlier represented the endowment and money back kind of policies. The terms and conditions of the payout are so complicated that understanding it may not be an easy task for many.
The premium, for a specific age and sum assured (SA), is paid for a limited period (say, 5 years) while the term of the plan is 15 years. Based on these parameters, the insurer will calculate a guaranteed maturity value and depending on that, will start paying a certain percentage of it as guaranteed cash amount starting the non-premium payment period (from the 6th year) till the end of the term.
Similarly, there could be a guaranteed plan in which every 5th year, 125 per cent of the premium is paid out, while the GA is added to policy each year, to be had on maturity along with SA (less amount paid every fifth year). In few other guarantee plans, the payout could be entirely on maturity, including GA and SA.
Contrary to the past when these policies were simple and straightforward, the newer versions are very complicated to understand. With guarantees thrown in, such plans may appear attractive, but the actual return in them is around 4 per cent per annum, or even lower.
Tip for insurance buyers:
One must not buy a life insurance for the purpose of saving tax. Traditional plans are inflexible and lock in funds for 15-30 years with a return of 2 to 5 per cent. so people must avoid buying traditional insurance plans, with or without inbuilt guarantees. Rather they should get a pure term insurance plan and park their savings in Public Provident Fund (PPF) or Equity Linked Savings Scheme (ELSS) for meeting long-term goals, while keeping the tax the tax liability at bay.