Don’t fall for ‘guaranteed’ returns

A recent newspaper advertisement by an insurance company caught the eye: “Enjoy guaranteed return of 135 per cent of premium paid. Invest ₹6 lakh and get ₹8.10 lakh, guaranteed!”

At first, the 135 per cent may appear alluring. But note that the insurer’s promise is an assurance for returning 135 per cent of the premium you pay. Otherwise, ₹8.1 lakh on ₹6 lakh is only a 35 per cent return. Given that the return takes six years to come by, the annualised return actually works out to a mere 5-6 per cent. So you have to be careful when interpreting returns indicated in advertisements. Keep in mind that traditional insurance products invest significantly in debt instruments and it is generally hard for them to deliver over six per cent annualised returns.

In guaranteed income plans, the guaranteed addition starts only after a certain period of time. Usually, the payout starts at the end of the premium payment term.

For instance, Aegon Religare’s iGuarantee plan promises to return 135 per cent of the premium. Here, the guaranteed income starts to flow from the end of the sixth year. If you pay a premium of ₹1 lakh for six years, you will get ₹1.35 lakh every year in the next six years. When calculating returns on such investment products, you have to take into account the time value of money too. So, for the above plan, the right way to work out returns is by calculating the internal rate of return (IRR).

This is the rate at which the present value of all cash you receive in future equals your current investment. If you don’t want to do the math with a paper and pen, Microsoft Excel has an IRR function to help you calculate investment returns easily.

If you put the initial payouts as negative figures and the later cash inflows as positive figures for the above example, you will see that the net return works out to 5.13 per cent.

Though this is higher than what a few other guaranteed products give, it is still not good enough. For the Aviva Family Income Builder plan, where one pays premium for 12 years and gets double the premium amount for the next 12 years, the IRR is slightly higher, at around 5.9 per cent.

There are many guaranteed income plans in the market today. Each insurer has his way of playing up returns. When they say returns, it may not actually be return on investment, but some guaranteed payout which can either be a percentage of premium or sum assured.

Guaranteed income plans are traditional insurance products where costs or investment avenues are not disclosed. And these plans are always non-participating plans, i.e. they do not get a share of the profits of the insurer. As insurers are allowed to refrain from sharing their profits with holders of non-participating policies, they are required to guarantee some return at the time the policy is taken itself.

However, since these plans invest largely in debt instruments and have a relatively high cost structure compared to ULIPs, their returns hardly beat even the rate of price rise.

Insurance watchdog IRDA has outlined several do’s and don’ts in its guidelines on advertisement and promotion by insurers.

For instance, it says an advertisement should not ‘highlight the potential benefits without giving a fair indication of risks’. Also, it should not use words or phrases which are likely to exaggerate the underlying benefits of the policy.

But as most ads explain details of the policy to an extent in fine print and carry a disclaimer, they tend to pass the scrutiny of the regulator. It is up to buyers to be fully aware of what they are getting into.