Thursday, September 10, 2009

Simple Investment/ Insurance?!

Here is a perfect example of insurance products taking investors for a grand ride.

Go to for a chart of various investment/ insurance options:

For example, consider the Retirement Plan. For a 30 year old male, with an investment of Rs.2000 per month for 30 years, the plan with an optimistic 10% per annum growth rate will give a pension of Rs.15,315 per month for life from the 31st year onwards.

But are these plans good investment options?

Now here is the catch. All of these plans are unit linked. Any unit linked plan is confusing - with a variety a charges (asset allocation charge, fund management charge, mortality charge, etc.) deducted differently (either in terms units or deducting directly from the investment) at different times (at the beginning of the investment, monthly or yearly) and unpredictable growth rates (which are limited by the IRDA to 6% and 10% for illustration purposes). So each of these plans need to be evaluated in terms of their overall attractiveness.

How can these plans be evaluated?

The best way to evaluate investment/ insurance plans is by separating the insurance (if bundled) and investment components. Compare the investment returns with that of a fixed deposit after adjusting best available rates for the bundled insurance (if any).

The Rs.15,315 pension per month for the Retirement Plan looks impressive on a cursory glance, especially for an outlay of just Rs.2,000 per month. The IRDA specified 6% and 10% returns are jacked up to 15% (or more) by the agents and last minute tax planning pressure gives in for most to opt for this plan.

But let's have a closer look. Let us put the Rs.2,000 per month in a bank fixed deposit (FD) at a nominal 8% interest compounded annually. That makes Rs.24,000 annual investment in FD. For the next 30 years, let us assume that the interest rate remains constant at 8%. The Rs.24,000 per annum investment at 8% will accumulate to Rs.29.36 lakhs.

This amount (Rs.29.36 lakhs) if reinvested again in FD at 8% interest will give annual interest of Rs.2.35 lakhs or a monthly interest of Rs.19,575 for life. Now compare with this the Rs.15,315 per month by the Retirement Plan. The FD comprehensively beats the returns of the Retirement Plan by a massive Rs.4,260 per month (21.8% more). And don't forget that the FD return is more or less guaranteed where as Retirement Plan's 10% return in risky and market dependent (it could be less, or more). Also, the accumulated Rs.29.36 lakhs is preserved for passing on to the next generation.

The case becomes even more compelling if we consider an SIP investment of Rs.2000 in a well diversified large cap mutual fund for 30 years (which can give returns in excess of 10% per annum) and then putting the cumulative amount in an FD to draw pension for life!

Click here to view an excel sheet with the above calculations.

So what's the verdict?

Isn't it obivious? In the above example a simple FD or a PPF (or mutual fund) would work much better than the pension plan. The situation is not very different for the other plans either.

Investors need to be extremely cautious while selecting investment options. Insurance companies trick the investor emotions with children plans and retirement plans and misleading returns. They have devised clever ways to disguise costs and still work within the regulatory framework to (mis) sell insurance products. Deviating from their fundamental purpose (and duty) of selling insurance, most of these companies (including nationalised ones) have aggressively marketed and promoted bundled and complicated products. The profit sucked out of the investor's money goes as profit to the insurance company and as hefty commissions to insurance agents.

Courtesy - Deepak Shenoy (@deepakshenoy)

Disclaimer: The views posted in this blog are my own and are based purely on my own way of assessments. Readers are  requested to consult with their financial/ insurance advisers before making any investment/ insurance decision, do their own due diligence and validate factual information.


Manish Chauhan said...


Very nice .. Its very nicely explained :) .. I am sure one do better with equites.. i will put up something like this using equity .. nice one ;0 .. keep it up .


Chetan said...

Hi... Nice Comparision.
I think FD rates are going down... and last 10 Year Average FD Rate is around 6-7 percent. While My personal Feeling says that some of the ULPP (Unit Linked Pension Plan) had given return higher than 15% of CAGR (SBI Life/Kotak/I-Pru) are the example.
Nowadays when IRDA has made an excellent implementation on the charges, i don't think your calculation is anymore relevant.

Ganesh said...

Agree with the FD rates going down and that some ULPPs given returns in excess of 15% CAGR. But remember that those are unit linked and hence risky. Go with a well diversified large cap mutual fund and you can expect similar, if not better, returns.

The charges are not taken out, it has been reduced. But the calculation is still valid. The results may change a bit. Let me know if you want me to evaluate some plan. Some are better, some are still bad.