Three Kinds Of Life Insurance - And How They're Mis-sold

'Caveat Emptor' is the Lain phrase for 'Let the buyer beware'. Given the sordid state of affairs with respect to how Life Insurance is distributed in our country, it's not surprising that this is one of its stated 'principles' (ironically).

Over the past decade, a very large number of unsuspecting investors have fallen prey to the dubious sales tactics that have, unfortunately, become synonymous with the industry. What's more, the losses accrued to clients through moneys foregone due to lapsation and/ or hefty upfront brokerages have filled the coffers of either the insurers themselves or their trusty agents. Talk about conflicted advice!

It's disappointing, then, that the recent consultation paper on IA (Investment Advisor) regulations seems to have exempted Life Insurance: since it 'falls outside the purview of SEBI' and under IRDAI's. The biggest loser in the midst of these regulatory turf wars is likely to be the hapless investor.

Don't get me wrong: I have nothing against Life Insurance, and I believe it to be one of the most critical aspects of a Financial Plan. It's only that Life Insurance is by and large sold wrongly in our country, and is presented to be something other than the 'risk transfer tool' that it's intended to be.

Over the years, I've been privy to a number of ways in which ill-fated investors have been saddled with Life Insurance in ways that aren't strictly conflict free, and I'll summarize a few of them below.

ULIP's
A ULIP combines Life Insurance with an 'investment' - think of it as a costly investment with a shaving of a life cover sprinkled on top. Although they've somewhat emerged from the chasm of the early 2000's when anything from 35% to 70% of your first year premiums were deducted as commissions, ULIP's are still not sold properly by many intermediaries.

How ULIP's are mis-sold.
First, your agent isn't telling you that combining a simple term plan with a top performing mutual fund will give you the same or better life cover, along with the potential for superior capital growth.

Second, there are a number of charges involved: premium allocation charges, fund management charges, switching costs and mortality costs, to name a few. Make sure you get a fix on them.

Third, ULIP's are sometimes still positioned as low risk/ assured return investments 'as they are insurance plans'. In reality, they are market linked, and therefore (depending upon the asset allocation chosen) will carry different degrees of risk. Risk isn't necessarily a bad thing, but it's vital that you're privy to the amount of risk you're actually taking.

Traditional Plans
Traditional Plans or 'non-linked' plans form the lion's share of first year premiums mobilized in India. The fundamental risk aversion that's intrinsic to our investing community has been the primary contributor to the 'safe haven' tag assigned to traditional plans. Traditional Plans are the ones where you make a fixed contribution every year, receive a life cover in return, plus some maturity benefits at the end of the payment term (or a few years thereafter, depending upon the policy structure).

How Traditional Plans are mis-sold.
First and foremost, the opacity of traditional plans and their benefits make them an automatic candidate for mis-selling. What kind of annualized return is "200% of sum assured" anyway? Rarely, if ever, will an insurance agent sit you down and show you the actual rate of return that your investments will earn under this category of policy. And why would they? At 4-5% per annum compounded, it would be a sheer embarrassment to disclose this figure.

Secondly, buyers are rarely made aware of the surrender values that are intrinsic to these policies. If you were to stop paying in the first half of the policy term, it's likely that you'd receive a small fraction of what you've paid from start till date. Although the percentage of surrender value does go up every year, the surrender penalties associated with traditional plans are staggering. Make sure you read the fine print before you invest.

Annuities
Aggressively advertised on metro station billboards and television as the 'ultimate gateway to a secure retirement', Annuities are, in a sense , Traditional Policies turned inside out. You commit a lump sum of money, and they safeguard you against the risk of living too long by assuring you an income stream until the day you pass into the great unknown.

How Annuities are mis-sold.
First and foremost, no insurance agent really positions this product as a part of a well-drafted post retirement cash flow plan. For instance: A retirement cash flow plan needs to account for inflation, but most annuities provide for a fixed some of money throughout the pay-out phase. Even the so called 'increasing' annuities scale up at 3% per annum (non-compounded), a pittance to say the least.

Secondly, most annuities will not have a surrender option built into them; once you're in, you're in for good! For the ones that do, the surrender value usually cuts a sorry figure, and the ability to surrender itself has a plethora of conditions attached. Make sure you understand both of the above points very clearly before you rush headlong into purchasing an annuity.

Thirdly, very few agents will explain to you that the annuities received are taxable as regular income, and so the post-tax CAGR from the plan (even assuming a fairly high life expectancy) will probably never exceed 5-6% per annum or thereabouts.

Lastly, watch out for ambiguous or meaningless text message campaigns such as "Invest Rs. 2269 per month and get PENSION of Rs. 25k + 4.3 Lac at maturity with **** Life". Invest Rs 2269 per month - for how long? Is the pension monthly or annual? Is this amount guaranteed or 'indicative'? These opaque messages are meaningless and misleading. Give them a pass.