Highest NAV guarantee plans under lens again

Invest in the fund and get highest NAV (net asset value) of last 7 years guaranteed. Now, this sounds lucrative and attractive, doesn’t it? Such funds are called the highest NAV guaranteed plan. They came in hordes few months ago and created a buzz. They are in news again. Insurance Regulatory and Development Authority (Irda) has decided to look into some of the products more closely and define guidelines for them. The highest NAV guaranteed funds are one of the products.

IRDA has been taking steps to correct the insurance market for quite some time and it has paid off well for the insurance holders. IRDA’s Ulip reforms earned kudos from insurance and finance watchers alike.

Why are highest NAV guaranteed funds controversial?
The major controversy is around the term ‘highest NAV’. The term is very simple and funds are right when they promise highest NAV of last 7 years when investors liquidate the fund. However, there is a difference between what the insurance holders understand by highest NAV and what the insurance companies mean.

Insurance companies certainly mean the highest NAV of the fund while the insurance holders confuse it with highest market level. Hence, they may assume the Sensex or the Nifty as benchmark for the highest NAV. Prima facie, this seems to be the wrong assumption on the part of the insurance holders. However, this did not go well with the regulators as the insurance agents may not provide the needed clarity.

Moreover, highest NAV guaranteed funds constitute 20% of all Ulips sold by insurance companies. Ulips are no more attractive because of the corrective measures taken by IRDA a few quarters ago. Hence, any directive by Irda on these funds will exert a high impact on insurance companies. Most of the fund houses, including ICICI Prudential, Birla Sun Life, Bajaj Allianz, SBI Life, and Reliance, have launched highest NAV guaranteed funds.

How can insurance companies promise highest NAV?
Let’s invert this question. When can a company promise highest NAV? The answer is when the company is fairly certain about the NAV. When can the companies be certain about the NAV? The companies can be certain when it invest in assets which do not fluctuate much and hence offer less risk. Which are the products that expose investors to less risk? Products that give less returns are backed by guarantee or equivalent such as government securities, bank fixed deposits, or even high-grade bonds issued by stable and blue chip firms.

Hence, the fund houses invest major part of the fund in equities and once it has got returns, some of the fund is shifted to debt to stabilise the returns and keep the promise of highest NAV. Let’s understand this with an example.

Let’s assume that a fund invests 100% in equity because the market is bullish. A bull market will take the funds value high. After a certain number of years, say 2-3 years, when the fund manager senses that market may not continue the bullish pattern or the market looks uncertain, it will shift major portion of the money in debt fund in such a manner that the debt fund grows up to match the highest NAV achieved in the bullish phase of the market.

What is wrong with highest NAV guaranteed funds?
The guarantee part can be adverse for investors. As the funds are supposed to provide the highest NAV, they do not take the risk and invest major part of the fund in debt instruments. This reduces the returns that otherwise may be possible from typical mutual funds over the long term. Moreover, management fees and administration charges eat up portions of the profit which can further deteriorate the returns from the highest NAV guaranteed funds.

Another aspect of discord is the management fee charged by the insurance providers. The fee could be as high as 40% of the policy premium in the first year.

Finally, the service history by insurance sellers is not encouraging. Most of the insurance sellers hardly show any interest once the policy is sold. This is because the major part of the fee is paid in the first year itself. Hence, sellers or direct selling agents do not have much incentive to serve the holder further.

What is expected from Irda?
Irda has been vociferous about these funds for quite some time. It is expected that IRDA will soon bring rules to regulate the details of highest NAV guaranteed funds. It is also expected to regularise the fee structure of highest NAV guaranteed funds.

IRDA is expected to do something about the upfront fee and make it more evenly spread throughout the life of the fund. This will compel insurance sellers to provide better services and post-sales support.

The writer is CEO at BankBazaar.com, an online marketplace for personal, home and car loans