How Rs 3.2 lacs became Rs 11,678 in 6 years?

The birth of a child brings joy not only to the parents but also to the parents of the
parents i.e. grandparents.  It is not uncommon to see grandparents making an
investment in the name of their grandchildren. They want to contribute towards their
grand children’s future.

This a case where a senior citizen picked up an investment product and invested
approximately Rs 3.2 lacs over 6 years. He ended up with a princely sum of Rs
11,678.

Shocked? Well, I am not making up the numbers. This is a true account.

How did this happen?

How Rs 3.2 lacs became Rs 11,678 in 6 years?

By the way, he didn’t invest in a penny stock. He merely purchased a child plan from
an insurance company.

He purchased (or was sold) HDFC Life Young Star Policy for Sum Assured of Rs
2.5 lacs with a quarterly premium of Rs 12,500. He paid the premium of Rs 3.2 lacs in
6.25 years. When the policy was closed by the insurance company, he got a princely
sum of Rs 11,678.

I came across this case in an article in an old edition of Money Life magazine and
have relied on the information shared in the post.

What went wrong?

A life insurance plan cannot be without an element of life insurance. And a ULIP is a
life insurance plan. Therefore, you must incur the cost for life insurance too (in the
form of mortality charges). By the way, under a term life insurance plan, you pay only
the mortality charges since there is no investment angle.
In any ULIP (unit-linked insurance plan), the mortality charges are recovered by
canceling units from your holdings (Wealth) to recover the charges. And that affects
your returns. The older you are, the more you must pay for the life cover. To put in a
different way, the older you are, greater the number of units that need to be sold to
recover mortality charges.
In any investment and insurance combo product such as a ULIP or an endowment
plans, your age will affect your returns.
Let’s look at the reasons.
Read: How various charges in ULIPs affect your returns?
Mortality Charges increase with age
Quite clearly, if the mortality charges are higher, a greater number of units will have
to be liquidated to recover mortality charges. And mortality charges will increase as
you grow older. Why?  The probability of a 65-year-old dying in the next 1 year is
much higher than the probability of a 25-year old dying in the next year.
A serious illness can increase mortality charges further.
In this specific case, the consumer had a coronary heart disease, which resulted in the
doubling of mortality charges. The reason is that the chances of the demise of the
policyholder are higher because of the illness.
Nature of child plans
The nature of child plans is such that in the event of the death of the policyholder, the
future premiums are paid by the insurance company. This rider is commonly known
as the waiver of premium rider.  By purchasing this rider, you ensure that the
investments for your child’s future continue in your absence. Noble thought per se.
However, in this specific case, since the applicant was a senior citizen, this rider came
at a high cost. Essentially, it will increase mortality charges even further.
Intermediary Commissions
This is an old case. The policy was sold in 2006. At the time, agent commissions in
ULIPs were very high. That would have also eaten into the corpus.
With revised ULIP guidelines, the commissions have been capped. Hence, this is no
longer as big a problem. Since the commissions are capped in ULIPs, the banks and
insurance agents have shunned ULIPs these days and started selling traditional plans
because traditional plans still offer high commissions.
Going by MoneyLife article, Rs 41,000 out of annual premium of Rs 50,000 (Rs
12,500 X 4) went towards mortality charges (life insurance cover).  Hardly
anything left for investment.

And that’s how an investment of Rs 3.2 lacs became Rs 11,678 in 6.25 years.

Where is the responsibility of the agent or insurance company?

This is a classic case of mis-selling. 

This is similar to a case where an investment of Rs 50,000 in an insurance plan from
SBI Life became Rs 248 in five years. Read more about the case here.
Did the agent not know that the mortality charges will eat heavily into returns?
Perhaps not. Ignorance is not innocence but we must extend the benefit of doubt.
Did the underwriting team of the insurance company not know? They surely did. The
underwriting team can’t be given benefit of doubt. Even if the process is automated,
such proposals should be red-flagged.

Nobody cared to inform the old man what he was getting into. His investment was
doomed since the day he purchased the plan.  The unfortunate part is that the
insurance agent and the insurance company didn’t do anything.
If he knew almost 80% of his annual investment will go towards life cover (that
perhaps he didn’t even need), would he have purchased the plan? I am quite sure he
would have stayed away.
I just wonder if the transaction took place at a branch of HDFC Bank. There is no
such mention in the MoneyLife article. Hence, it will be prudent to give HDFC Bank
the benefit of doubt. However, the bankers typically do not have any qualms in selling
the most inappropriate products to their customers.
For all you know, the gentleman may have walked into the bank branch just to open
an FD or a recurring deposit for his grandchild. And banks do not let you open FD so
easily these days. You can read about the experience of one of my clients when he
walked into a bank branch for opening a PPF account in this post.
What should you do?
1 Do not mix investment and insurance.
2 Assess if you need a life cover. You may not need life insurance during retirement.
3 Develop greater awareness about financial products. Do not trust anyone. Look
into a potential conflict of interest. You need to be aware to ask the right kind
of questions. If you rely too much on others, you will be taken for a ride
sooner or later.
4 Keep track of your investments: If the policyholder had kept track of growth in
investment corpus, he would have realized that something was wrong quite
early.
5 Do not fall for fancy product names. Do not fall for emotional sale pitches. Make
a rational and objective decision.
6 Do not visit a bank for seeking investment advice. I have said this many times
before. Most bank officials are not well trained. Even if they are trained well,
they are trained well in making sales and earning commissions for the banks.
The bank officials never pay any heed to your requirements. You are better off
going to a casino and gamble your money away.  It will give you a greater
thrill now and less heartburn later.
7 Seek professional advice, if required. When it comes to financial products, it
seems everybody is an expert. Nobody holds back in offering unsolicited
advice when it comes to investments. Seek professional advice from a SEBI
Registered Investment Advisor. You might have to pay a fee. However, the
cost of purchasing a poor financial product is much higher than the fee that
you pay to an advisor.
Additional Read
1 MoneyLife Article
2 After tax on LTCG on equity funds, are ULIPs better than mutual funds?
3 How (not) to invest for Children’s Education?
4 Do’s and Don’ts while planning for children’s future
5 How to select the best ULIP for your portfolio?
6 No parent should purchase LIC Jeevan Tarun
7 Don’t invest in LIC New Children’s Money Back plan
The article was originally published in August, 2016.

How (not) to invest for Children’s education?

Whenever I deride an insurance and investment combo plan, I get many queries about
how to invest for your kids’ education.
When you are planning for kids’ education, your biggest concerns are:
8 Where to invest i.e. choosing the right product to accumulate funds for their
education
9 If something happens to you, your planned savings for the kid’s education must
not suffer.
For now, let’s focus on the concern no. 2. We will briefly touch upon concern no. 1 in
the latter part of the post.
Now, when we talk about the demise of the parent (and concomitant loss of
income stream), the financial product that comes to mind is life insurance.
Therefore, insurance companies have launched products with the nomenclature or the
purpose to save for kids’ education. Let’s call such plans child plans.
Any child plan will fall in one of the two following structures.
Let’s call these Structure 1 and Structure 2.
Structure 1
8 The child is the life assured.
9 You have an option to purchase a rider for waiver of premium in the event of the
demise of the parent.
Structure 1 is quite idiotic.
Why, in this world, do you need insurance on kid’s life?
Insurance companies know that too. However, the problem is that the insurance
companies sell insurance products. And an insurance product must have an element of
insurance. They can’t sell a pure investment product.
If they cover the parent’s life, the mortality charges will be higher because charges
increase with age. That’s why they cover the child’s life. This helps reduce the impact
of mortality charges on your returns.
Read: Your age affects your returns in ULIPs and traditional plans
However, you do not need life cover on your kid’s life. Why, then, would you
want to incur a single penny (as mortality charges) for the life cover you do not
need?
In the event of the demise of the parent, such plans don’t really help. After all, the
parent’s life was never insured. How will the family pay the premium?
Insurance companies have figured that out too.
You do have an option to add a rider for waiver of premium in the event of the demise
of the parent. However, the rider comes at a cost (in the form of higher premium).
And a higher cost compromises returns.
LIC Jeevan Tarun falls under Structure 1.  As you can read in the post on LIC
Jeevan Tarun, the return on the base plan is likely to be between 6% and 7% p.a. And
this is before adding the waiver of premium rider. With the rider, you can expect
returns to be much less.
LIC Jeevan Tarun is not the only plan with such a structure. I am sure there are
many other traditional plans and ULIPs from other life insurance companies
too.
Verdict: It is nonsense to purchase any life insurance plan where the insurance is
on the life of the child. Insurance plans with structure 1 shall be avoided.

Structure 2
1 The parent is the life assured. Life insurance is not on the life of the child.
2 The plan is a type-I ULIP. Type I ULIP helps reduce the impact of mortality
charges. Read this post to find out how.
3 In the event of the death of the parent, the child gets the Sum Assured. Future
premium instalments are waived off. Instead, the insurance company keeps
making the premium payment on behalf of the parent. Essentially, the
 investment for the child’s education continues even in the absence of the
parent. At the time of maturity, the child (or the family) gets the Fund Value.
4 If the parent survives until maturity, the child (family) gets the Fund Value.
There may be similar offerings under traditional life insurance plans too. However,
from what I have seen, this structure is quite popular in ULIPs.
In my opinion, Structure 2 makes far greater sense than Structure 1. Parent’s life
is insured (and not the kids).  Structure 2 is easier to understand too.
However, Structure 2 has issues that any ULIP grapples with.
1 The life cover you purchase is a multiple of annual premium you can afford. You
may end up being under-insured.
2 Underwriting in ULIPs is quite lax. Therefore, mortality charges (money that you
goes towards providing you life cover) is quite high as compared to a term life
insurance plan. A term insurance plan has only mortality charges. High
mortality charges eat into your returns.
3 Your age will affect your returns.
4 You can’t exit an under-performer. You are stuck.
5 You can always exit after 5 years if required but that’s not enough flexibility.
Point to Note
Insurance companies may come up with very fancy structures. However, do
remember everything comes at a cost.
If a policy 1 offers better benefits than policy 2, do compare the mortality charges
(and other charges) for the two plans. Quite likely, the mortality charges (as per the
mortality table) for the Policy 1 will be much higher (even though Policy 1 and Policy
2 may be from the same insurer).
How to invest for children’s education?
Here is what you should do.
1 Avoid any plan that has the child as the life insured (Structure 1 plan). Both
traditional plans and ULIPs may have this structure.
2 Avoid any traditional life insurance plan (both Structure 1 and Structure 2). You
will get guaranteed poor returns.
3 Purchase a pure term life insurance plan and invest the remaining amount in mutual
funds, PPF, Sukanya Samriddhi accounts.
4 Have a target for the education corpus and plan investments accordingly.
5 The exact allocation shall depend on the age of your child (investment horizon) and
your risk appetite.
If you are a new investor (and your kid is quite young), you can start with a
50:50 portfolio. 50% in a balanced (aggressive hybrid) or a multi-cap fund and
50% in PPF (or SSY). Experienced investors can manage with more aggressive
portfolios too.
Do remember PPF and SSY have long lock-in periods. You can’t invest in these
products (open new accounts) for short or medium term goals.
I prefer PPF over SSY (despite better returns in SSY) since PPF offers better
flexibility. In any case, SSY is available only for the girl child. And you can always
have a mix of PPF and SSY for your daughter.
Fans of traditional life insurance plans may argue that mutual funds do not offer
a guarantee of good returns. Investor behaviour can also play spoilsport.  Yes, that’s
right.
However, traditional plans give guaranteed poor returns. I will still take my chances
with mutual funds. By the way, ULIPs (both Structure 1 and Structure 2) also provide
market linked returns (just like mutual funds).
I will avoid the discussion on numbers in this post. I have done such analysis in my
previous posts. You can refer to Post 1 Post 2. Do remember the spreadsheet analysis
can never fully show the lack of flexibility in ULIPs.
I must concede
Structure 2 child plans are easier to understand and relate to. You know, for sure,
that the investment for child’s education will continue even if you are not around.
You know you have to pay a certain amount every year and that’s it. To be honest,
that’s what makes such plans attractive to many investors. And, I wouldn’t blame
them for it.
In case of a mix of a term plan and mutual funds/PPF/ULIP, after the demise of the
parent, your family will get the money. However, even with all the money, your
spouse still needs to make investment decisions. This may not be as simple, especially
for someone who has never taken interest in finance and investments.
However, this is one part where it is your responsibility to train them or have a
trusted friend/financial planner/ investment advisor who can guide them in your
absence. To start with, keep a record of all your investments and insurance policies at
one place and tell your family about it.
Taking a minor digression, there are terms plans that you can provide your family
with a stream of income in addition to lumpsum payout. If you are worried about how
your family will manage investments to generate income, this may provide extra
cushion.
You might argue that maturity proceeds of a ULIP are exempt from tax while
Long-term capital gains on the sale of mutual funds are taxable.
LTCG on equity funds is taxed at 10% while LTCG on debt funds is taxed at 20%
(after indexation). Budget 2018 has handed this great advantage to ULIPs. However, I
still prefer mutual funds over ULIPs. I have discussed the reasons in detail in this
post. By the way, PPF and SSY are still exempt from tax.
How do you save for your kid’s education? Do let me know your thoughts.
Image Credit: Pixabay.com

With Traditional Life Insurance plans and ULIPs, your Age affects the returns
August 17, 2017 by Deepesh Raghaw 5 Comments
You are here: Home / Insurance / With Traditional Life Insurance plans and ULIPs,
your Age affects the returns
Yes, your age at the time of purchase affects the return that you earn in investment
and insurance combo products such as traditional life insurance plans and ULIPs.
Everything else being same, lower the age at the time of purchase, better will be your
returns.
It is best to understand this with the help of examples. Let’s first start with a
traditional plan.
How your age affects returns in traditional plans?
Let’s consider a traditional life insurance plan to see the effect.
LIC New Jeevan Anand is a non-linked participating life insurance plan.
Simple reversionary bonus is linked to Sum Assured and is announced at the end of
each year. Remember the bonus is paid at the time of policy maturity only.
In addition, the policyholder will get Final Additional Bonus (FAB) at the time of
maturity. Only FAB announced in the year of maturity will be applicable to your
policy.
At maturity, you get Sum Assured + Vested Simple Reversionary Bonuses +
Final Additional Bonus
You can see both the bonuses are linked to Sum Assured.
Therefore, if Amit (30) and Rahul (50) purchase LIC New Jeevan Anand for a Sum
Assured of Rs 10 lacs on the same day, both will end up with the same maturity
corpus.
However, they will pay different annual premiums and this will affect returns.
Let’s assume both of them purchase the plan for 20 years with Sum Assured of Rs 10
lacs.
The premium for Amit (30) will be Rs 58,362 in the first year and Rs 57,105 for the
subsequent years.
The premium for Rahul (50) will be Rs 72,085 in the first year and Rs 70,533 for
the subsequent years.
Let’s further assume LIC announces a reversionary bonus of Rs 45 (per thousand of
Sum Assured) for the next 20 years. Additionally, it announces a FAB of Rs 500 (per
thousand of Sum Assured) in the year of maturity.
Reversionary Bonus per year will be Rs 10 lac/1,000 X 45 = Rs 45,000
FAB in the year of maturity will be Rs 10 lacs/1,000 X 500 = Rs 5 lacs
Maturity corpus = Rs 10 lacs (Sum Assured) +
                                       Rs 9 lacs (Rs 45,000 X 20)+
                                     Rs 5 lacs (FAB) = Rs 24 lacs

Both end up with Rs 24 lacs at maturity.

Amit earns a return of 6.62% p.a.
On the other hand, since Rahul pays a much higher premium for the same
maturity value, he ends up with 4.81% p.a.
The effect of age at the time of purchase of policy affects the return.
Quite clearly, if you purchase at a higher age, the already low returns of
traditional plans become even lower.
Does this happen with ULIPs too?
Yes, you can expect this in ULIPs too.
ULIPs work in a slightly different fashion as compared to traditional plan.
In case of traditional plans, your annual premium itself is a function of age and Sum
Assured. The function is a black-box and I don’t how it works.
In case of ULIPs, you are asked to choose premium that you can pay. Sum Assured is
a multiple of the annual premium. Let’s say 10 times. So, if you agree to pay an
annual premium of Rs 1 lac, the Sum Assured will be Rs 10 lacs. You can see age is
nowhere part of the equation in this case.
However, in case of ULIPs, your units are periodically sold off to recover mortality
charges. These mortality charges go towards providing you the life cover.
Clearly, mortality charges increase with age (similar to how term life insurance
premium increases with age).
Therefore, more and more units have to be redeemed to provide those mortality
charges.
For instance, Amit purchases a ULIP at the age of 30 and Rahul aged 50 purchases
the same ULIP (and chooses the same fund) on the same date. The annual premium
and Sum Assured are also same.
Amit will end up with much larger corpus than Rahul at the time of maturity(say after
15 years).
This is because Amit would have paid lesser mortality charges. For Rahul, greater
number of units would have to be redeemed to provide for the charges.
Amit will end up with greater number of units than Rahul (even though NAV of the
fund unit will be same) and with a larger corpus than Rahul.
With ULIP, Fund NAV may not be indicative of your returns
This brings me to a slightly unrelated but an important discussion.
Many times, during sales presentation of ULIPs, salesperson points to the growth in
NAV to show how your corpus would have grown with a particular ULIP.  That past
returns do not guarantee future returns is another matter altogether.
However, even if the past were to repeat itself, you will not earn the same return as
shown in the illustration.
Why?
This is because some of your units will have to be redeemed to recover various
charges including mortality charges. FMC (perhaps) etc.
Just to give an example, suppose you get 1000 units of Rs 100 each when you invest
in the plan. At the end of 5 years, the NAV has grown from Rs 100 to Rs 200. That’s
a return of 14% p.a.
However, if the number of units goes down to say 900 (100 units used to square off
various charges), your return is only 12.4% p.a. (Rs 1 lac has grown to 900X200= 1.8
lacs).
Even though the NAV of your fund has doubled, your investment has not doubled.
PersonalFinancePlan Take
Many times, I have talked about high charges, lack of flexibility, difficulty in exit and
lack of portability to build a case against insurance-cum-investment plans such as
traditional life insurance plans and ULIPs.
However, discussion about how age affects returns deserves merit too. Clearly,
the impact is higher for an older person. This is an aspect many salespersons
conveniently ignore or don’ know.
Elderly persons or retired persons make for easy targets to sell these kinds of plans.
For such people, these plans are a double blow.
Firstly, they may not need life cover and hence there is no point paying for life cover.
Secondly, there is no point paying so heavily for the life coverage.  This dampens
your returns.
Remember, NAV is not affected. Only the number of units that you own goes
down.
Another point to note is that if you have an existing illness (at an old age, you are
likely to have an illness), your mortality charges may even get loaded (increased due
to illness). This will dampen your returns further.
Here is an egregious example where an investor ended up with Rs 11,000 after
investing Rs 3.2 lacs over 6 years in a ULIP.
If you keep insurance and investment separate, you wouldn’t face this issue.
Keep things simple.