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Beware of the insurance terminology

A few days back, one of my clients sent me the following e-mail seeking my opinion on a particular insurance policy:

"Hi Sanjay,
Attached is the file sent by ****** Bank rep. who are selling this product. Pls advise if suitable. It gives 7.5% assured return, plus 6 to 10% additional, complete total amount is tax free. If ok, then i intend to invest about Rs. 2 lakhs p.a.
tks n regards."

Frankly speaking, I was surprised by this as it seemed too good to be true. When I went into the details of the Plan, I realised that the terms used by the insurance company were highly misleading. Now, this particular client of mine is a well-informed investor. So I was wondering that if he could misunderstand the policy terms, then it would be too much to expect for an average investor to understand the policy and take an informed decision.

The policy required that my client pay Rs.2 lakhs premium for 7 years i.e. a total payout of Rs.14 lakhs (the Sum Assured was Rs.8,32,051). He was promised a guaranteed amount of Rs.62404 from 7th to 20th year and a guaranteed maturity payout of Rs.894,455 in the 21st year. Further, depending on the actual performance of the fund, a higher payout would be payable. In this regard, calculations at 6% and 10% returns were worked out.

Here's what I discovered. The 7.5% assured return is NOT the return that we understand in the normal parlance. It is NOT the return on our investment of Rs.14 lakhs. It is 7.5% of the SUM ASSURED of Rs.8.32 lakhs i.e. Rs.62,404. Now in actual terms Rs.62,404 on Rs.14 lakhs works out to just 4.46%. But this is not the end of the story.

This payment of Rs.62404 begins only after 7 years. So no returns for first 7 years. Therefore, the effective guaranteed return over 21 years works out to ONLY 1.90%. Yes, that's right - the effective guaranteed return on investment is just Rs.1.90% - and not 7.5% as people are being led to believe. My contention is why use the word 'return', which can be easily misunderstood as return on one's investment.

But even if the fund generates 6%, we will get only 4.86% and at 10% gross fund yield, we will get only 7.78%. I am sure we can make much better returns than this by investing in pure investment products.

There is another issue with the guaranteed products. If insurance companies invest in equity and markets are down, they will have to give out money from their own pocket if they have to honour the guarantee. Since insurance company will not like to make a loss, they will invest the money mainly in debt products. So one can very well forget about earning higher returns. A normal non-guaranteed product is comparatively a better choice as over long term one can expect good returns because the fund manager can afford to invest in equities. [Of course, it may still find it difficult to give better returns than a normal equity MF].

I hope IRDA and insurance companies make sincere efforts to simply the language so that there is no scope for such ambiguities.

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