Money’s back. Your money!

Akhilesh Tilotia

There is a great joy in receiving money and if it comes on its own, we feel elated! Whether what we received was already rightfully our own, becomes secondary to the pleasure of the receipt. Insurance companies and dividend-distributing mutual funds make use of this feeling of joy to innovate products that appeal psychologically, rather than financially to the consumer. Let us take the case of money-back insurance policies.

A money-back insurance policy is a combination of investment and insurance. In a conventional endowment insurance policy, if the policy holder survives the tenure of the policy, he gets the sum assured (the amount for which his life was insured at) along with the bonuses that have accumulated over the years. If he dies in between, his nominee gets the sum assured plus the accumulated bonus. Unlike the conventional policies where the “sum assured” plus accumulated bonuses are payable at the end of the policy, in case of a money back policy, there is staggered payment through the tenure of the policy.

A friend of mine called me to celebrate the first birthday of his kid and proudly told me that he has become a good father for this kid, at least financially. Further probing revealed that he had purchased a children’s money-back policy. He was happy that his son would get Rs 50 lakh at the age of 24, which will finance his higher education.

“And do you know what the best thing is,” he continued, “I will start getting back money from the insurance company! The starting premium is Rs 126,321 (Rs 123,150 as investment and Rs 3,171 as payor rider premium) which reduces from 4th year onwards such that I get back Rs 39,500 in the last year of the policy! Also, a payor rider ensures that even if I am not around or incapacitated due to some reasons, the policy will continue”. The payor rider is  attached to a child policy to ensure that if the person paying the premium (my friend in this case) dies or faces a permanent disability of some kind, then all future premiums on the policy are waived off till the child reaches 21 years or the person paying the premium turns 60, whichever comes earlier. 

Is it really good?

IRDA guidelines require that all illustrations shown by insurance firms show growth of either 6% or 10% p.a. on a non-volatile basis. We will look at the guaranteed and the 10% returns only. Note, however, that the 10% return is highly unlikely given that the company will invest - by the design and the bye-laws of the policy - in government and secure securities. Other than this they would have to pay out huge commissions to their agents. These two things will ensure that even 10% growth on a money back policy is difficult to achieve. Also as we shall see, 10% growth, does not mean a 10% return. 

The company is guaranteeing my friend Rs 50 lakh, when his son turns 24. This guaranteed payment essentially ensures an annual return of 4% p.a. “There is a guaranteed return - something that MFs don’t promise me,” said my friend. “I understand that the returns guaranteed are only 4%, but still I know for sure that I will make that return.” At such low rates of return, you are eroding your capital!

Now let us look at the money back part of the policy: The company says that if it makes profits on the investment it makes, it will share it with the policy holder. Assuming the 10% return, the company expects a schedule as shown in the exhibit. The company declares a bonus, which is netted off against the premium payable by the investor. Hence, in the year 3, when the bonus of Rs 23,050 is announced, the premium for the next year is reduced by that amount. Given that we do not know how much bonus the company will declare, the premium every year will be a fluctuating number.

Now note the rate of return when the insurance company is “earning 10%”. The return in this case works out to 7.19% on a maturity amount of around Rs 51.74 lakh, which is lower than 10% due to adjustment of “payor rider premium”, company administration charges, agent’s commission, etc. Note that this is lower than the return from PPF, which guarantees a return of 8%.

The interesting part of the policy is the payor rider which waives the premium in case some unfortunate event happens to my friend. There is no separate life cover in this policy. However, if my friend were to take a term life cover for himself, then even if something were to happen to him, his son would get the sum assured, which he can invest such that the amount grows till he reaches 24.

What is a better option?

Consider getting a term insurance (for a 30 year male, a Rs 50 lakh cover should cost around Rs 15,000 a year). Ideally my friend should invest the remaining amount of Rs 1,11,321 per year into PPF, but current regulations do not allow an individual to invest more than Rs 70,000 p.a. into a single PPF account. What can be done is that my friend can invest another Rs 30,000 p.a. into a PPF account opened in his wife’s name. Doing this will allow him to claim the maximum benefit of Rs 1 lakh under Section 80 C.

After 23 years, this investment of Rs 1 lakh p.a. will amount to Rs 65.76 lakh, which is higher than what the insurance firms promises - and yes, all of this is tax free! So we see that by investing Rs 1,15,000 p.a. (Rs 1,00,000 towards PPF + Rs 15,000 towards term insurance), which is around Rs 11,000 lesser than the premium being paid in case of the money-back policy, he can build a greater corpus. Also, if something unfortunate were to happen to my friend, then his son gets the Rs 50 lakh life cover.

Un-bundle insurance and investments

This should be your guiding mantra in almost every financial decision involving insurance and investment. Else you will end up with a policy where your own money is returned to you as money back!

tilotia.akhilesh@parkfa.com