Tread cautiously if a financial product offers guarantees

It has been said many times not to mix insurance and investment. To maximise gains, one should purchase the cheapest insurance option (read term insurance) and invest the balance funds optimally.

The recently-launched Birla Sun Life Foresight Plan gives the combined benefit of insurance and opportunity to invest. It is a unit-linked insurance plan (Ulip) with unique guarantees on investment. It comes under two options: self managed and guaranteed option.

Self managed option is similar to any other Ulips wherein your premium amount after deducting all charges is invested in the market. The plan provides 10 options to choose for investment, ranging from 100% investment in equities to 100% in debt instruments.

The other option is guaranteed option, which is available only if one chooses the 5-year premium payment term. We have heard a lot about guaranteed NAV funds which promise to give the highest NAV achieved during the initial 5 to 8 years of the policy term, irrespective of the fund value at the time of maturity.

Birla Sun Life Foresight Plan’s guaranteed option provides that benefit along with an additional guarantee. It also guarantees that the premium is invested on the best day of the year, irrespective of the actual date of payment of premium.

For instance, suppose the fund value during the start of the year is Rs1,00,000, the day you paid your premium, it was Rs1,05,000 and by the end of the year it increases to Rs1,15,000. However, during that year, the fund had hit a low of Rs95,000.

This option assumes that the investment is made during the lowest point of year, which is Rs95,000 in our example, and will guarantee the return of ~21% instead of the actual return of ~10% for that year.

Such guaranteed return is calculated for all the years in which premium is paid and is determined at the end of the 5th year of policy. The guaranteed amount at the time of the maturity will be higher of the fund value, highest NAV achieved during the first 7 years of policy or the NAV derived from the above additional guarantee.

Sounds great? Actually it is not. Since the variation in the fund value will not be significant if one considers the fact that the major portion of the fund will be invested in debt instruments and the high cost of providing this guarantee.

The fund management charge is 1.35% for the first year and increases by 0.25% (single premium option) or by 0.40% (5 years premium payment term) every year, which over a period of 10 years, can become quite significant. This is in addition to the premium allocation charge of 5% of basic premium.

The minimum premium amount of Rs200,000 for single premium option and Rs100,000 for 5 years premium payment term is also quite high as point of entry in to this plan. Further, despite such high premiums, the plan fails to provide adequate insurance cover with the maximum cover of just Rs30,00,000 on a premium of Rs1,00,000 p.a. (assuming individual, age of less than 45 years, opts for 5 year premium payment term) and one will be required to purchase additional cover.

Whether it makes sense to go for this plan?
Any financial product with an element of guarantee in it should be dealt cautiously. Each guarantee has its cost and as the number of guarantees increases the cost also rises.  The cost in this plan is (i) in the form of additional fund management charges, which can increase substantially as the policy progresses, and (ii) reduced returns.

To provide the guarantee, over a period of time, the fund will be required to park major portion of the investment in debt instruments. Thus, over a period of 10 years, the annualised returns will not be significant. Surely, it is difficult to predict the returns; however, after deducting various charges, it will be surprising if the returns are in double digits.

Thus, this is not an ideal plan for those looking for long-term value creation. Even for conservative investors, who prefers security of returns, Bachhat advises to go for bank fixed deposits (which now a days are offering interest up to 10% pa) or opt for long-term debt funds. As regards to insurance cover, go for cheaper term cover.

The writer is a chartered accountant and blogs at http://bachhat.blogspot.com. He can be reached at vishalbharatshah@gmail.com