What’s The Return On Your Traditional Plan?

Are you considering buying a “traditional” life insurance plan that guarantees you certain benefits but doesn’t directly show you where your money is invested, like a ULIP (Unit Linked Insurance Plan) does? If yes, chances are that you won’t have a valid answer to the seemingly innocuous (and important!) question – “what are the returns that I can expect from this policy?”

Two factors drive this ignorance. First, the ‘benefits’ from traditional life insurance policies are represented with a head-spinning degree of opacity. Second, the benefits themselves really accrue as a factor or the “sum assured” attached with the policy, and not as a factor of the money you’ve actually contributed out of your pocket. Counterintuitively, the regulator mandates that the benefit illustrations that need to be shown to investors represent the returns displayed on the moneys contributed – this only makes matters worse.

A typical representation of the benefits of such plans is this: an annual bonus is declared as “Rs. X per Rs. 1000 Sum Assured”, and a Final Bonus (or Loyalty Bonus) of Rs. Y per Rs. 1000 of sum assured. X and Y vary depending upon the Sum Assured attached to the policy, the type of policy, and the term of the policy. Consider this: the “Final Additional Bonus” for LIC’s “group 1” policies with a Sum Assured of Rs. 2 lakhs or more, ranged from Rs. 20 per 1,000 for 15-year term policies, to Rs. 450 per 1,000 for 25-year term policies, to Rs. 3,550 for 40-year term policies! Similarly, the Annual Bonuses (also called “Simple Reversionary Bonuses” ranged from Rs. 21 per 1,000 for short term plans to Rs. 70 per 1,000 for whole life plans.

An illusion of high returns

It’s worth noting here that the ‘bonuses’ declared thus get added to your maturity amount, but do not compound. For instance, if you hold a policy with a SA value of Rs. 10 lakhs for which you’re paying Rs. 50,000 per annum for 20-years, and the policy declares a bonus of Rs. 40 per 1,000 of SA, a bonus of Rs. 40,000 will be strapped on to your maturity amount. This creates an illusion of a high return (Rs. 40,000 on an investment of Rs. 50,000 – wow!), but this isn’t quite the case – remember that this “return” will be available to you only 20 years down the line – without any further growth at all.

How to guesstimate returns

By now, you’ve probably realised that its nigh impossible to arrive at a precise estimate of the actual ‘returns’ you’ll earn from your traditional policy, as this number is contingent upon the annual bonus rates that will be decided by your insurer from time to time. You can, however, draw up a simple cash flow table by considering the historical average bonus rate that your policy (or policy bucket) has been declaring thus far. Similarly, you can also use the historical average “Final Bonus” number to project what your final bonus is likely to be – bear in mind though, that the lengthy time frame involved will add more than just an element of uncertainty to this calculation!

Use the IRR formula in Excel

Once you’ve got your projected annual cashflows neatly arranged, assign minus signs to the annual contributions that you’ll be making, and positive signs to the projected cash flows you’ll be receiving. Post this step, a simple IRR calculation in an excel sheet will do the trick

An interesting fact

You’ll likely infer, maybe to your surprise, that the “returns” earned from your traditional policy will work out to 4-6% per annum. There’s a rather simple reason for this: traditional plans are mandated to invest the bulk of their portfolios into G-Secs. Factor in the hefty commission that’s deducted upfront and paid to your agent, and it now becomes clear why these policies are really just geared to provide returns ranging from G-Sec yield minus 3% for shorter term policies, to G-Sec Yield minus 1% for the longer-term ones. Considering their long-drawn time horizons, they may not be the best option. Choose wisely.