After ULIPs fell from grace, traditional plans are selling fast. In another first from Moneylife, Raj Pradhan exposes the terrible returns from traditional plans that customers seem oblivious to

My cousin Roshan was facing a dilemma. He wanted to buy term life insurance; but his father, my uncle, insisted on his buying an endowment or money-back policy—traditional insurance in trade parlance. My uncle has done well in his business; but when he was saving, the options were limited—mainly fixed deposits and traditional insurance products. Thanks to their personal experience, people like him have a deep belief in traditional insurance. He told Roshan how he got his employees a money-back product which gave insurance cover as well as 3.5% returns on investment.

Yes, that’s the kind of return you would get if you buy a traditional plan, depending on which one you buy. If you are not careful about what exactly you are buying—and most of us are not—it could be a pathetic 2%-4%.
A lot of people are taking to traditional plans. After experiencing that unit-linked insurance plans (ULIPs) have been disasters, traditional plans seem to be the natural choice for most. Life Insurance Corporation of India (LIC) is doing roaring business selling these plans and private sector players are eager to catch up. Just as a matter of record, six years ago when Moneylife was launched and most personal finance publications were happy to confer awards for best ULIPs, we had suggested in our very second issue that you should avoid ULIPs. The regulator woke up four years later; today, nobody wants a ULIP. Well, ULIPs look great compared to traditional plans. So, you know what we are talking about. “It is like moving back to the Stone Age,” says Dr P Nandagopal, managing director and chief executive officer, IndiaFirst Life Insurance.

My cousin Roshan had dabbled in a ULIP product a few years ago, but received negative returns even after three years. He surrendered the policy. If he buys a traditional plan, he will remain in the dark on performance. These plans are too opaque. The surrender value he gets will be minuscule if he were to surrender it just the way he did with the ULIP. Will he be jumping from a frying pan into the fire, if he heeds to my uncle’s advice?

We have looked at traditional plans extensively and believe that most of them are not for anybody who is even minimally financially literate. Some traditional products can be confusing even for insurance experts. Moneylife insurance desk often gets queries from policyholders about how much they will get on maturity. Insurance companies will throw in terms like simple reversionary bonus, compound reversionary bonus, terminal bonus rate calculated for each year or, in some cases, one-time terminal bonus, guaranteed returns and so on. The bonus rates and any other non-guaranteed additions can vary hugely over the period depending on the performance across products, overheads, market returns from debt instruments and so on.

There is no way you can be assured of returns based on today’s bonus rates. It is a myth that the bonus rates will only increase. Can a person who understands only simple products like fixed deposits (FDs) dabble in traditional insurance products with ease? Interestingly, media have been pointing out that the returns from such products are in the range of 5% to 7%. These estimates are made without subtracting the mortality charges. These charges are not explicit in traditional products, but can be deduced from mortality tables used by the insurance company. Shockingly, once we made all the calculations, the way it should be done, we found a wide swing from 8% to less than 2% returns on investment depending on the chosen product, insurance company and policy term. Without bonus, some of the products can give returns of less than 1% or even negative returns! These are toxic products. Steer clear of at least these insurance products, if you insist on going the traditional way. As far as we know, this is the first time any publication has lifted the curtain on traditional products and offered the cold numbers for all to see.

Push or Shove?
It all starts with how insurance is sold. We never voluntarily buy an insurance policy; we have to be pushed into it—by insurance agents and advertisements. And there are huge costs attached to selling something customers are not ready to buy. Even then, it is not easy to sell. Indian life insurers recorded a 21.35% drop in premium collection during the first six months of the current financial year. Incentivising agents is the key to closing a sale. To push you into buying a policy, commissions on traditional products can get as high as 40% of the policy premium in the first year. The first-year commission on ULIPs is 7%-12%. Loaded with such huge commissions, are traditional insurance plans beneficial for customers?

Well, insurance companies themselves cannot make up their minds on the answer. The acting chairman of LIC was quoted as saying, “In the past two years, we have tried to consciously shift to traditional products. Earlier, we had ULIPs and traditional products in the ratio of 60:40, which has now reversed.” Now hear what the HDFC Life CEO was quoted as stating: “The shift to traditional plans is certainly a worrisome trend. Every insurer is suddenly focusing on these policies. I can’t stop my distributors from selling traditional products, but I would take steps to ensure that these policies don’t account for more than 35% of our total portfolio.”

While LIC caps the maximum commission for traditional insurance products at 35%, IRDA (Insurance Regulatory and Development Authority) allows private insurers to give up to 40% commission. There is talk about some insurers offering even higher commission to cut into LIC’s business. Such high commissions restrict the insurance company’s ability to offer a decent surrender value, in case a customer wishes to surrender the policy. The restrictive surrender value makes traditional products highly illiquid barring the option to take loan against 90% of the surrender value, in some plans. LIC gives loan at 9% interest today, while some private insurers may charge 14%. High commissions also impact the bonus rate an insurance company can afford to pay; hence, customer returns are lower.

While the intermediary commission will depend on the type of the traditional product, policy term and insurance company decision, many customers think they are smart when they negotiate a hefty pass-back. Sharing the commission only helps the sale get completed with the customer living under the illusion of having snatched a good deal.

According to a veteran LIC agent, “Traditional products, like endowment, will give decent returns only if the policy term is greater than 15 years and the customer stays for the full term.” We can say that for LIC, but private insurers don’t have that long a track record and, hence, buyers should beware. LIC’s endowment plan (table 14) has been there for ages and is easier to understand than many other products. Don’t get browbeaten by intermediaries into buying a product that you don’t understand, especially the combination plans created by the intermediary. Don’t confuse with LIC’s Endowment Plus which is a ULIP.

Dr Nandagopal told Moneylife, “Insurers have started pushing traditional plans. If the customer is choosing after understanding the relative merits, it is fine. If it is sold based on agent commission of 40%, then it is not fine. It should not be due to the power of the commission kickback given by an agent.”

Traditional insurance products, in general, are low in insurance component. There are products that may not match the requirements of the Direct Taxes Code (DTC) proposals, which would offer tax-breaks only if the sum assured (SA) is at least 20 times the annual premium. Traditional plans with low insurance (e.g., maximum SA of less than five times premium), plans with insurance decreasing over the policy term or insurance linked to return of premium with or without interest (e.g., SA is premium plus 6% interest per annum), will be the first products to go on the negative list of the insurance regulator.

Toxic Insurance Products
The HDFC Life CEO had made a bold statement recently: “IRDA has changed ULIPs by bringing down the charges. But it has done nothing about traditional plans. Why is it not bringing the commission down on these products? The fact of the matter is, LIC which has 60%-65% of the market share still sells 70% traditional products. Of this, almost 50% goes into government securities and, therefore, IRDA is not doing anything about it.”

Unfortunately, HDFC Life also has traditional products; one of its products, in existence since 2003, is particularly toxic. It goes by the benign title of ‘Savings Assurance Plan’. For starters, it has no real insurance component. In case of death during the first year of policy commencement, a basic benefit of 80% of the premiums received will be paid to the nominee of the life assured. How did IRDA allow such an atrocious clause? In case of death after the first year, the amount payable on death will be the ‘lesser of’: The sum assured plus any attaching bonuses or the total of the premiums paid plus interest at 6% annually compounded. The annual premium payable for a sum assured of Rs1 lakh is Rs12,016 for a policy term of 10 years. Based on the current bonus level, the customer will make less than 2% return on investment, unless there is a decent terminal bonus which is not declared at this time. This is the first product that HDFC Life needs to get rid of.

Last year, IRDA suddenly discovered that universal life policy (ULP) was just too harmful and decided to scrap it after it had been in the market for over a year. ULPs soon found their way back, re-christened as variable insurance policy (VIP). LIC and SBI Life Insurance have launched VIPs which have astronomical charges of 27.5% in the first year, 7.5% in the second and third years and 5% in each year thereafter, of the premium paid. LIC’s Bima Account is guaranteeing 6%pa (per annum) not on the investment but what remains after deducting all the charges. The plan will lose money for the first five years. Bima Account I of LIC too will make no money for the first five years and the policy term is only five to seven years. What might save the day for Bima Accounts is a hefty bonus from LIC. But there is no track record of bonus for such products. LIC has sold over two lakh Bima Account policies. It shows that there are many suckers who will blindly go with the brand even if the product is harmful.

The Bonus Rate—Best Kept Secret
The cornerstone of returns from traditional plans is the bonus; but this is one of the most opaque aspects of such plans. A conversation with some intermediaries will give a false impression that the bonus rate of LIC and final additional bonus (FAB) has never been reduced. They may give future calculation of returns based on the current bonus rate and FAB; but, remember, it is not a guaranteed figure. Your actual returns may be higher or lower than what the current rates offer. Bonus rates can vary hugely with debt market interest rates. According to LIC sources, “There is an impact of debt market on bonus rates, but we try to minimise the reduction by curtailing the operating expenses. Bonus rates have increased for ‘with profit’ plans this year.”

The LIC bonus rate for a 25-year endowment plan had variations from Rs52 per thousand sum assured (PTSA) in 1986 to a peak figure of Rs78 PTSA in 2000; it is now down to Rs48 PTSA. The bonus rates are in line with the maximum rates offered by private insurers and are dictated by returns on the debt instruments.
The FAB has increased from Rs320 PTSA in the year 2000 to peak in 2008-09 to Rs750 PTSA and is now drastically down to Rs450 PTSA. The implication of the changes are that if your 25-year old endowment plan of Rs10 lakh SA matured in 2009, you got Rs7.5 lakh as FAB, but if your policy matured in 2010 or 2011, you got FAB of only Rs4.5 lakh. Talk about getting short-changed by Rs3 lakh due to the policy maturing in a wrong year! To give some credit to LIC, FAB increased for policy term of 34 years and above in 2010. For example, FAB on policy term of 40 years and above will have increased from Rs3,200 PTSA to Rs3,550 PTSA.We are not trying to trash LIC’s returns; even after reduction of FAB, the estimated rate of return on a 25-year endowment policy term based on the current bonus and FAB, the customer may get 7.59%pa at the end of the policy term. If we add back the intermediary commission, LIC’s cost will be 8.16% in this case. The yield on long-term government securities today is 8.6% which means the returns from endowment products are close to it; plus one gets tax savings on entry and exit.

According to Girish Malik, vice-president-life insurance, Nandi Insurance Broking, “The mortality charges increase with age; hence, the premium is more for higher age. The return on investment component is close to the one for the younger age. It is clear that the rate of return is significantly lower for a 10-year policy compared to a 25-year policy.” There are enough margins for LIC in this case. Lapsed policies and favourable mortality experience also add to LIC profits. LIC mortality tables of 1994-96 will need to be revamped with increasing longevity.

Unfortunately, traditional products are opaque not just about the charges and commission but also for estimating returns. Comparing products can be a Herculean task. IRDA requires companies to give illustrations with 6% and 10% returns. How does one correlate it with actual bonus rates and FAB of the company? The products may not offer guaranteed returns, but will offer guaranteed nasty surprises in terms of returns, as they vary from insurer to insurer; also, there are variations between products of the same company. The more complicated the product you buy, the bigger will be the shock.

Online aggregators like PolicyBazaar.com and MyInsuranceClub.com offer comparisons and a direct buy online platform for some traditional plans but there is no pass-back of commission to the customer. They offer comparison of product features and possible tax-adjusted returns; but, unlike term plans, the nature of traditional products is such that it is not easy to decipher them.

Traditional Vs ULIP Vs FD
The target for traditional products are risk-averse investors who traditionally put money into fixed deposits, public provident fund, national savings certificates and other secured instruments. Tax savings on entry and exit has been a major pull for traditional insurance products. According to Rituraj Bhattacharya, head of market management & product development at Bajaj Allianz Life Insurance, “People, especially in tier-2 and tier-3 cities, were looking for avenues of investment and diversification along with investment risk exposure, whether it is in equity, debt or liquid funds, in varying proportions. This was offered by ULIP.”

But customers bent on investing in traditional products have a better and simple option which agents don’t push. Customers can choose debt/money-market option of ULIP which can technically give slightly better returns than traditional products over the same policy term due to lower charges, but the returns are not guaranteed. The surrender charges in ULIP are capped; hence, the customer is better off. The new rules for ULIPs have forced the commissions to be spread over the years instead of front-loading. This makes commissions lower than those on traditional products.

According to Akshay Mehrotra, chief marketing officer, PolicyBazaar.com, “Most customers look at insurance as a saving and investment option; they may not be able to understand the core difference between traditional endowment and ULIP endowment. ULIPs have become more beneficial for customers since the 2010 IRDA guidelines; unfortunately, agents discourage the purchase of ULIPs today due to a lower distribution margin. We see many customers who come online and compare both traditional endowment and ULIPs.”

According to Deepak Yohannan, CEO, MyInsuranceClub.com, “It is unfortunate that traditional plans are completely driven by commissions. Many customers don’t know that there is a debt investment option in ULIP. The switch option in ULIP is hardly used.” Dr Nandagopal adds, “Traditional plans are complex products that are not transparent. ULIPs score high with choice of investment, lower charges and transparency, from the customer’s point of view. Traditional plans are inferior to ULIPs and have completely disappeared in many markets. They do well in certain markets where there are powerful interests.”

Traditional products have come back with a vengeance since the shift away from ULIPs. While asset allocation does emphasise some investment in debt instruments, does a traditional product offer any advantage over bank FDs? Neither beats inflation and, hence, it is necessary to have equity exposure to grow wealth over the long term and to balance your portfolio from time to time. Is the customer taking a huge risk as traditional products offer non-guaranteed returns? Some may offer guaranteed returns, but these are woefully low.

Private Players Are the Worst
LIC is the king of the traditional insurance business and private insurers are not able to catch up with LIC. Why have traditional products from private insurers been beaten hollow? Mr Yohannan says, “LIC did not go overly aggressive in the ULIP market and it helped their brand. It is a myth that everyone wants to go with pure returns. How many people understand the stock market? Most people just want safe, secure products with an element of insurance attached to them. People also want an assurance that the company will be around after 20 years even though IRDA ensures solvency margin of all insurance companies.”

Private insurers have no track record of bonus: LIC distributes 95% of its profits to policyholders while private insurers are required to distribute only 90%. Many insurers don’t even have any declared FAB as polices have not yet matured. In other cases, the FAB may not be on par with LIC’s. According to our sources, “HDFC Life and ICICI Prudential Life Insurance are planning to declare FAB for policies completing 10 years.” If true, this is good news, considering that LIC’s endowment plans offer FAB only for policy terms of 15 years and above. Any insurer giving a higher bonus rate and FAB than LIC will surely make their products competitive.

Some insurers may declare a decent bonus, but FAB is unknown and susceptible to manipulation to lower the overall returns. LIC is certainly a well-oiled machine with a track record of bonus and FAB. Private insurers will consider the impact on their profitability while declaring bonus and FAB.

Wide variation: The future bonus rates and FAB should not have wild swings from one year to the next. ICICI Prudential Life’s bonus rates have fluctuated in the past four years. The compounded reversionary bonus (CRB)rate from 2006 to 2010 was 3.25%, 3%, 2.25% and 4%, respectively. How does a customer know what will come next year?

New products: LIC’s successful product, Jeevan Anand, offers endowment and whole life benefits. Birla Sun Life Insurance has launched Vision which competes with Jeevan Anand. Based on the bonus rate and other additions for 2011, it has a slight edge over Jeevan Anand for higher SA, along with drawback related to age limits. The question is whether Birla Sunlife Vision bonus rate will be able to sustain and keep its edge in future years; or is it just a tactic to capture market share? It is easier to offer better bonus rates when the number of policies is low; but will it keep up with increased business?
All the product benefits come at a price paid via policy premium. Jeevan Anand gives endowment benefits at the end of the policy term. The policy continues and pays SA on death or age 100. The premium will be slightly higher than that on an endowment plan and the benefits at the end of the policy term will be slightly lower than that on an endowment plan. This is because the policy continues and additional benefit of SA is paid on death or age 100.

Poor returns: Bajaj Allianz Super Saver has declared CRB of 1.25% and terminal bonus of 0.5%. The rate of return on premium for a 25-year policy, 25-year policyholder and Rs10 lakh SA is less than 3.5%. Compare this with LIC’s endowment policy for the same parameters having a return on premium of 7.21%. How is such a huge difference justified? Can it be due to higher overheads of private insurers as LIC’s costs are spread across several crores of policies?  

Confusing bonus: LIC’s bonus rates are simple reversionary bonus (SRB). For a policy term of 20 years and above, the bonus of Rs48 PTSA will be accumulated every year and paid at the end of the policy term. Bajaj Allianz CashRich Insurance Plan has declared CRB of 3%. The bonus rate, if declared as equivalent SRB, will be 4.758% or Rs47.58 PTSA at the end of the 30 years.
CRB will give increasing bonus rate every year as the policy term increases. In that case, LIC’s endowment policy wins for a policy term of 20 to 30 years. After that, Bajaj Allianz CashRich will give better bonus rates.

LIC endowment FAB for a 25-year old policy is Rs450 PTSA which is a one-time calculation. Bajaj Allianz CashRich has declared a terminal bonus of 0.5%. Bajaj Allianz’s terminal bonus is calculated on the SA and for each completed year of the policy subject to at least five years and is payable on maturity or death. For a 25-year old policy, it will work out to only Rs125 PTSA.
Kotak Life Insurance has announced returns of up to 8% on traditional products. It is a new trick, as 8% is calculated on the accumulation account and not SA. The accumulation (premium minus charges) will be significantly lower than SA, except when the policy term is coming to an end. The effective bonus rate is insignificant. No wonder, readers write to Moneylife insurance desk asking how much their traditional policy will give at the end of the term. It is devilishly difficult to calculate. The premise on which traditional products are sold is: If you cannot convince, confuse the customer. That will make the sale! After all, the buyer also wants to come across as someone who is financially savvy. Besides, the larger the deception, the longer it takes to decipher it.

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