An attractive sales pitch about a product instinctively raises queries in the audience's mind. Our financial planning team at Personalfn recently received one such query regarding a unit linked insurance plan (ULIP) from a leading public sector insurance company, which we would like to share with our visitors.
First let's understand the client's profile.
The client, a 28-Yr old high net worth individual (HNI), was advised by his insurance agent to go for a ULIP with a sum assured of Rs 500,000, and the policy term being 46 years. In this way, he would be insured till the age of 74 years. The agent recommended that he opt for a single premium policy, which amounts to a one-time premium of Rs 100,000.
The client was advised to go for the equity option, where he could have 100% equity exposure and hence earn higher returns. The returns projected to him were calculated at a rate of 15% CAGR.
The ULIP has an annual charge of 2%, annual administration charge of Rs 720 and fund management charge of 1.5%.
As always we examined this case with the objective of analysing whether the product would add value to the client's portfolio and fulfil his insurance/investment objectives. This is what we concluded:
To begin with, the client did not have a life cover. So our basic objective was to ensure that the product he was being recommended provided him adequate insurance cover.
Individuals in quest of life insurance are often too returns-centric forgetting that they must first and foremost have adequate life cover that can provide financial stability to their dependents in their absence. So priority has to be given to the insurance component. The investment component i.e. returns can come separately at a later stage.
In this case, the client was being recommended an insurance cover of Rs 500,000, which is a pittance for an HNI. In case of an unfortunate event, the amount of Rs 500,000 would not even service the family car let alone provide financial stability to the family.
A brief analysis of the product and the returns generated by it over a period of 46 years (the policy term) tells us, that the investment corpus will take 12 years to exceed Rs 500,000. So if the client expires before that, he will get only the sum assured i.e. Rs 500,000!
Ideally, a person of his financial standing should get himself insured for a much larger amount and not subject his life cover to the vagaries of the stock markets.
For some strange reason, the returns projected to the client have been calculated at an optimistic rate of 15% CAGR. According to IRDA's (Insurance And Regulatory Development Authority) revised ULIP guidelines, agents are bound to show benefit illustrations based on an optimistic estimate of 10% (simple growth or CAGR) and a conservative estimate of 6%. Moreover, the guidelines dictate that clients are to sign on the benefit illustration.
Not surprisingly, the agent did not take our client's acknowledgement on the 15% CAGR illustration since he was violating the ULIP guidelines. If reported by the client, backed by his signature, this would have amounted to loss of agency for the insurance agent.
Our solution
We advocate that all individuals (HNI or otherwise) buy a term plan for an amount that can be considered reasonable given their life style, income, expenses and contingent expenses among others. The capital appreciation can be taken care of through investments like NSC (National Savings Certificate), PPF (Public Provident Fund), mutual funds/stocks and fixed deposits.
For the investment component, mutual funds can play an important role in the client's portfolio. Mutual funds give investors an opportunity to access equity and debt markets in a convenient manner. Given that our client does not have the time and competence to track these markets, mutual funds become an obvious choice.
In terms of expenses, mutual funds are more cost-effective than the ULIP that was recommended to our client. The annual expenses incurred on the ULIP are 3.50% (2.00% recurring and 1.50% fund management charges). In contrast, mutual funds are managed at an annual expense of 2.50% (maximum) of net assets. Over a period of 48 years, there is a good chance this number could reduce since according to the expenses slab defined by SEBI, higher net assets result in lower expenses.
Put simply, the client must on priority opt for term plan that, in his absence, can provide adequate financial stability to his family. He can then consider investing to take care of the returns. If you are wondering why ULIPs do not feature in our solution to the client, it's because in this particular case the ULIP was too expensive. If there is a ULIP that can match the returns and the lower expenses of a mutual fund, it can be an option for investors.
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