What would be your return from traditional policies?

A lot of people buy traditional insurance plans such as endowment plans. Have you thought of calculating returns on such plans, especially since you may have invested in them as investments? Unfortunately, traditional products are opaque not just about the charges and commission but also for estimating returns. There are no guaranteed returns. IRDA requires companies to give illustrations with 6% and 10% returns but the cornerstone of returns from traditional plans have traditionally come from “bonus”. A conversation with some intermediaries will give a false impression that the bonus rate of LIC and final additional bonus (FAB) has never been reduced. The tendency is then to add the bonus rates an insurer gave in the past, while calculating returns.

How does one correlate it with actual bonus rates and FAB of the company? The products may not offer guaranteed returns, but will offer guaranteed nasty surprises in terms of returns, as they vary from insurer to insurer; also, there are variations between products of the same company. The more complicated the product you buy, the bigger will be the shock.

But, remember, bonus is not a guaranteed figure. Your actual returns may be higher or lower than depending on what the FAB is. Bonus rates can vary hugely with debt market interest rates. According to LIC sources, “There is an impact of debt market on bonus rates, but we try to minimise the reduction by curtailing the operating expenses. Bonus rates have increased for ‘with profit’ plans this year.”

How much can bonus rates vary? LIC’s bonus rate for a 25-year endowment plan had variations from Rs52 per thousand sum assured (PTSA) in 1986 to a peak figure of Rs78 PTSA in 2000. It is now down to Rs48 PTSA. The bonus rates are in line with the maximum rates offered by private insurers and are dictated by returns on the debt instruments.

The FAB has increased from Rs320 PTSA in the year 2000 to peak in 2008-09 to Rs750 PTSA and is now drastically down to Rs450 PTSA. The implication of the changes are that if your 25-year old endowment plan of Rs10 lakh SA matured in 2009, you got Rs7.5 lakh as FAB, but if your policy matured in 2010 or 2011, you got FAB of only Rs4.5 lakh. Talk about getting short-changed by Rs3 lakh due to the policy maturing in a wrong year!

Even after reduction of FAB, the estimated rate of return on a 25-year endowment policy term based on the current bonus and FAB, the customer may get 7.59%pa at the end of the policy term. The yield on long-term government securities today is 8.6% which means the returns from endowment products are 1% below government bond yields. The only advantage: one gets tax savings on entry and exit.

To give some credit to LIC, it increased FAB for policy term of 34 years and above in 2010. For example, FAB on policy term of 40 years and above will have increased from Rs3,200 PTSA to Rs3,550 PTSA.

If it is so hard to arrive at the expected return of one plan, imagine how hard it is to compare products.

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