Four Ways In Which Traditional Insurance Plan illustrations Mislead
Ever walked away from a Life Insurance product pitch thinking “wow, that sounds great!” – only to discover later that it wasn’t quite as good as it seemed? Don’t worry, you’re not alone. Traditional Plans are notorious for smartly disguising their lack of returns in a shroud of opaque fine print. Here are five very common ways in which they tend to mislead investors.
Bonus = Per cent of Sum Assured
Say, you’ve taken up a traditional plan with an annual premium of Rs 1 lakh and a “sum assured” of Rs 20 lakh. The annual bonus of 3-4 percent is declared as a percentage of the sum assured, and this comes across as a fantastic return (for instance, an annual bonus of Rs. 80,000 on a net premium paid of Rs. 1 lakh sounds very much like an “80 per cent return”). However, this is just an eyewash, because the Rs. 80,000 is not going to be paid out today, but perhaps 20 odd years later. This drastically diminishes the actual time value of this seemingly large bonus.
Back ending the big prize
Most endowment plans have a seemingly large reward at the end of the policy. For instance, a popular endowment plan which requires the policy buyer to pay Rs. 1 lakh plus taxes for 10 years, subsequently pays out a lump sum of Rs. 10.30 Lakhs in the 37th year! These kinds of features prey on the very common human fallacy to focus on absolute numbers without putting them properly in perspective. For instance, assuming a 6% inflation, Rs. 10.30 Lakhs is really the equivalent of just 1.2 Lakhs or so today.
Sudden “gap” years
Endowment plans smartly incorporate a few gaps here and a few gaps there. For instance, a moneyback plan may incorporate a 5-year gap between the completion of your pay and the return of the moneys in the form of sequential, annual cash flows. Even a 5-year gap can bring down the long-term IRR of your product from 6.5% or so to sub 5%! Needless to say, this works out in favour of the insurer; the less they have to pay to you, the more they’ll have left over as distributable profits.
The death benefit as an “extra”
Another way in which Traditional Plans mislead, is by showcasing the “death benefit” component of the plan as “something extra”. However, know that when it comes to Life Insurance (or any other Financial Product, for that matter), nothing comes free of cost. The costs associated with providing the death benefit cover are built into the structure of the plan itself, and thee costs impinge upon the returns of the policy without adding any serious value in terms of risk transfer.
End Note: When it comes to traditional plans, trawl through the fine print carefully. Consult a professional Advisor who will be able to construct a cashflow table from the policy specific, and arrive at an internal rate of return. Weight out whether the policy in question will add much value to your personal risk management plan. You will probably end up discovering that the plan isn’t quite as hot as you thought!
