The idea of guaranteed returns can be tempting. Here's all you wanted to know about them

Guarantee is a very appealing word. Particularly, for Indian investors. How else would you explain the hold of fixed deposits and endowment plans over them? As long as their investment delivers the returns promised, they don't mind losing out on the possibility of earning higher returns. To tap investors with this mindset, especially in the backdrop of a volatile equity market, some life insurers have launched guaranteed-NAV (net asset value) Ulips in recent months. "Since the past two months, the markets have been fairly uncertain. Also, interest rates are high at the moment. Hence, such products are being launched," says Sanjeev Pujari, appointed actuary, SBI Life. While these products could work for some, it's best to understand their intricacies to determine their suitability instead of simply going by their nomenclature.

TYPES OF GUARANTEED ULIPS

"Guaranteed-NAV products essentially belong to two categories - one that comes with a pre-specified NAV assurance and the other where the highest NAV achieved by the fund during the initial 7 or 10 years is used to calculate the fund value at maturity," informs Pujari. In the case of the former, the NAV is pre-fixed at say . 15 or . 20. Investments are primarily directed towards fixed-income securities whose tenure is aligned with the policy's maturity. If the policy is set to mature after 10 years, the premiums will be in-vested in a 10-year G-sec or a 10-year corporate bond. In the case of highest NAVguaranteed Ulips, you start with a NAV of . 10 with no guarantee at the outset. Initially, almost 100% of the premium amount is invested in equities. As the maturity date draws closer, this allocation can change and the composition will be a mix of debt and equity. "If there is a downturn, then the debt component will be increased in a proportion required to ensure the guarantee," adds Pujari.

THE MECHANISM

These products offer the highest NAV recorded over a given period. The premium is payable for a fixed period of around 5 years. "In the NAV build-up phase, the reset dates set by the companies are exercised. Reset dates are pre-decided dates fixed by insurance companies to record NAVs," says Jayant Pai, V-P, Parag Parikh Financial Advisory Services. Then comes the accumulation phase, which refers to the tenure remaining after all the reset dates have been exercised. On maturity, you are entitled to the highest of the fund value at maturity or the fund value as calculated using the highest recorded NAV during the pre-defined period. Adds Fabien Jeudy, chief actuarial officer, Birla Sun Life Insurance, which offered the first highest NAV-guaranteed Ulip in March 2008: "The highest NAV registered by the fund during the first seven years is taken into account while calculating the redemption proceeds. Offering and meeting the guarantee promise necessitates monitoring the fund composition on a daily basis. If the fund manager and the actuary see the stock market faltering, some portion will be reallocated to fixed instruments. Once they see signs of market recovery, they could get back into equity." In case of the insured's death, the fund value or the sum assured, whichever is higher, is given to the dependent.

Regular Ulips offer several fund options, ranging from pure equity to only debt, and the policyholder is allowed to choose between these funds. However, with guaranteed-NAV Ulips, this is not possible. Here, you will have to settle for the capital or return guarantee fund that the company offers for such Ulips. "Insurance companies invest the premium based on the number of years the product is offered for. For instance, assume . 100 is invested for five years and the sum is divided in a 70:30 proportion," says Pai. "Now, 70% is invested in bonds. Let's assume these bonds give a return of 9% p.a i.e., . 6.30. So, in five years, the total return will be . 31.50. When we add the initial . 70 to this, we re-cover the sum of . 100." Thus, the capital is guaranteed and the balance amount too will yield some return over and above this sum.

THE INDUSTRY PERSPECTIVE

They are projected as products that offer the chance to participate in the growth from equities, while containing the possible losses by investing in fixed income avenues. "Individuals too can manage their portfolios on their own, but at their own risk. If the equity market tanks, you can hope that it will recover, but there is no guarantee. Here, you have a fund manager and an actuary managing this risk on a daily basis," says Jeudy. "Those who want higher returns through equities, but not at the cost of the volatility of the market can look at these products," says Bharti AXA Life V-P, product and pricing, Rajeev Kumar.

THE LIMITING FACTORS

The key one is perhaps common to all Ulips - despite the cap on Ulip charges introduced in September 2010, financial planners continue to believe that the cost has still not come down to reasonable levels. This apart, there are certain other limitations too. "For one, the guarantee is applicable only at maturity. That is, if you decide to withdraw the money prematurely, the minimum assured return will not be offered to you. This apart, a guaranteed-return Ulip does not offer too many fund options. Those who wish to have a wider choice can look at regular Ulips," says Jeudy. Then, due to the guarantee factor, most such products will tend to be heavily invested in debt, which limits the fund's ability to earn higher returns. Also, the highest-recorded-NAV is linked to the fund's own performance and not the stock market. Therefore, if the market has done well, you cannot assume that it will reflect in your fund's returns. Rather, its performance will largely depend on the fund manager's skills and efficiency. And to offer this expertise, the insurance company will levy an additional guaranteeing charge. Remember, this is not subject to the Ulip charges ceiling imposed by the Irda. Also, the structure of these products is quite complex.

ASCERTAIN THEIR SUITABILITY

Finally, any investment proposal, even if it seems fail-safe, should be evaluated in the context of your needs and of course, risk appetite. "It is a Ulip product, so if you need insurance, you can consider it; if not, then you shouldn't look at a Ulip. Clients will opt for the guarantee products if they are not comfortable taking a risk," says Jeudy. "They will suit risk-averse policyholders who do not mind foregoing the return which a non-guaranteed Ulip or an equity mutual fund could yield," adds Pai of PPFAS.

Source : ET