Wednesday, June 17, 2009

Are Money Back Policies productive?

‘Save a little money each month and at the end of the year, you will be surprised at how little you have’ – Ernest Haskins Confused??? Aren’t you..... Time and again, financial advisors have propagated the rewards one can reap by saving little by little. And here, we are contemplating otherwise!!! Well, you need not be Ernest Haskins to believe the truth behind this aphorism. Simply analyse the returns likely to accrue from the money back (insurance) policy you have invested in, and the above adage would flash like a golden truth, literally.

Money back policies are one of the most traditional insurance cum investment policies and have been widely promoted and distributed by the insurance companies. Unlike a regular endowment plan, where the policy amount (sum assured) is receivable either on death or at the end of the policy term, money back policies ensure that the survivor receives a certain percentage of sum assured regularly during the term of the policy. This ensures periodic cash inflows in the hands of the survivor to meet various financial needs that might crop up with time.

The unique selling point (USP) of this product however lies in the fact that in the event of the unfortunate death of the insured, the nominee shall be eligible to receive the entire sum assured irrespective of the payments already made as ‘moneyback’ . To simplify this USP, assume a 30-year old youth with a money-back policy of Rs 10 lakh for a period of 20 years. Now assuming a 20% pay-out (of the sum assured) every five years, this individual would have received Rs 6 lakh by the end of the fifteenth year, with the remaining Rs 4 lakh to be received on maturity. But if the individual dies before the end of the 20th year, the nominee shall be entitled to the entire sum assured of Rs 10 lakh, resulting in total pay-out of Rs 16 lakh by the insurance company.

Sounds interesting, really, but probably for those who wish or plan to die early in life leaving their wealth for their heirs to enjoy! And for those who are in no hurry to meet the ‘Yamraj’ , a little pondering and analysis of the premiums payable on money back plans would help to structure their prospective investments.

Money back policies are probably one of the costliest traditional insurance products available in the market. And this is obviously because the insurance companies are unable to milk the premiums received by them for the entire investment tenure. To have a gist of the cost structure of a money back policy - a simple 20 year money back policy from LIC calls for a premium of over Rs 6,300 per one lakh sum assured for a healthy individual aged 30 years as against Rs 4,900 charged by a pure endowment plan. A term plan, on the other hand, shall be available at 1/20th of this cost.

Thus, though money back plans are usually promoted as schemes taking care of both insurance and investment needs of the insured, a deeper look into these schemes is bound to unsettle the investors. An ETIG study of 10 popular money back policies reveals that the sum total of premiums paid during the entire policy tenure are either higher than or equal to the total receivables from these schemes. This is despite the fact that most of these schemes promise guaranteed additions upon maturity.

While we have not considered the proportion of variable pay-outs or bonuses which may be declared by the insurance companies from time to time - as the same are not guaranteed - even if the same are incorporated , they are not likely to make a significant difference to the probable pay-outs by insurance companies. Thus, while these money back schemes do justify their insurance features, they grossly fail to answer the thesis behind the investment structure of the policy. An investment, after all, implies growth of capital and not its diminution.

The insurance companies are likely to argue that since they periodically repay a part of the sum assured, the same can then be reinvested by the investors in other investment avenues. While the point is valid and well noted, it definitely calls for a counter argument.

If the investor ultimately has to seek other investment avenues in the middle of the policy tenure, why not do so in the beginning itself and invest the amount in instruments that yield returns rather than use it for paying premiums. And as far as the insurance needs are concerned, a pure term plan would do just the same at a premium, which is nearly 1/20th of that paid for money back.

(A term plan from LIC would charge Rs 3,227 per annum for Rs 10 lakh policy vis-àvis Rs 62,796 per annum levied by a money back policy.)

The hefty premiums demanded by the various insurance cum investment policies make one ponder over the productivity of such investments. While both insurance and investment are equally important and need to be provided for fairly early in life, it is advisable to split the two objectives. Let insurance companies take care of insurance needs and there are opportunities aplenty as far as investments are concerned.

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