The word ‘guarantee’ brings a sort of relief to anyone who hears it. In the days of economic slump and fast-falling interest rates at major banks, ‘guaranteed return’ has a different allure. Anyone, who does investments, knows a thing or two about ‘reinvestment risk’. The risk basically is that your return may drop the next time you reinvest. You may have secured a good return today, but tomorrow getting the same return will be impossible. Look at every additional investment avenue around you, returns are falling. Bank FDs, post office schemes, recurring deposits, government bonds, etc., form a long list of hitherto popular products where returns have fallen along with the passage of time. For investors, who want a certain amount of fixed income, ‘guaranteed return’ is manna straight from heaven. To catch this trend, many insurance companies have started promoting ‘guaranteed return’ products in the past few weeks. Some companies have even launched new products to catch the eye-balls of investors. But are guaranteed insurance products all good? What are the pros and cons of such products? In this article, we will try to answer these questions and more.
Most guaranteed insurance products, sometimes called guaranteed benefit plan, are traditional life insurance plans. Traditionally, term life insurance or simple life insurance has been a hard-sell. This is because simple life insurance only gives a pay-out when the life insured dies during the policy tenure. What if the person survives? You get nothing! This is why life insurance companies used the ‘guaranteed return’ pitch to sell life insurance. And, by all accounts, everyone was happy. Guaranteed return insurance plans offer a fixed return, and so there is always some return: either for the policyholder if they survive or the nominee if the policyholder dies.
At the core of all guaranteed return products is life insurance + return. As years went by, life insurers have started marketing guaranteed insurance plans with various flexibilities like lump sum and regular income options, offer customized policy term and premium payment term options. The life insurance component in a guaranteed return product is easy to understand: the life cover is to safeguard your loved ones, in case of an unforeseen event (like your death).
Thus, guaranteed return insurance investment plans are packaged as customized, one-stop insurance solutions to help individuals achieve their financial goals. For customers, this becomes an attractive proposition. This is because they offer dual benefits of guaranteed savings and protection in a single policy with a shorter pay commitment.
Additionally, life insurance plans provide tax benefits. The tax sops are on the premiums paid and benefits received, as per the prevailing income tax laws.
Returns low at best
There are a few unsavory things about guaranteed return investment plans. One, returns are quite low. Using internal rate of return, guaranteed return plans offer at best five per cent. This low return is a function of the cost of guarantee. Insurers have cost structures which require expenses. So, at the end of it all, when the investor is finally paid net of all expenses, the guaranteed return is not great. Life insurance companies pay good commissions to agents who sell the products to buyers. While it can be debated what value agents really bring to the customers’ table other than making the transactions happen, they get paid. This money indirectly goes out of the kitty of customers. Insurance companies reckon, and probably, rightly so that insurance plans are push-products, which require ‘selling.’ At the end of the day, every single rupee that is paid to non-customer for any life insurance plan, including selling guaranteed return products, is one rupee less for the company and for the policyholder.
Secondly, adjusted for inflation, guaranteed returns are no big deal. With 4-5 per cent annual inflation (this is a low-end estimate), a five per cent guaranteed return is virtually nothing. For anybody with regular income needs, it may be okay to have a five per cent return guarantee for 20 years. But truthfully such returns do not really make much of a difference. The only problem for an average investor is that they do not have access or awareness to long-term financial resources that can give such guarantees. As a result, investors are kind of compelled to go into low-return products that deliver guarantee at a cost.
Thirdly, there are many safe avenues that deliver reasonable returns for one-time investments. However, guaranteed returns from life insurers are only true if the investor keeps on paying premium for at least 5-7 years. You have to keep investing and stay the course. The guarantee is not as strong if you somehow are unable to pay the premium over the set period. In comparison, Public Provident Fund (PPF), bank deposits and small-saving schemes offer a standing guarantee for a fixed return even for a one-time investment.
The writer is a journalist with 14 years of experience