Banks and ever prevalent mis-selling of plans

During one of my bank visits last week, I was entreated by one “Advisor” to invest in a product for ‘my children’s future’. Curious to understand more about what he would suggest, I sat down to listen to his pitch.

He suggested that I invest in a product for which I will start receiving payouts after seven years and a lump sum payout after seventeen years. His pitch was as follows:

• Invest Rs100,000 per year for the next seven years (5 and 10 years premium paying options are also available)
• After seven years, I would receive Rs fifty thousand per year for the next ten years (this is an assured return and it is not market linked)
• At the end of the seventeenth (17th) year, there will be a final payout of Rs twelve lakhs (again this is an assured return and it is not market linked) If I don’t need the lump sum payment after 17 years, I can convert it into an annuity and I will receive Rs10,000 per month for the rest of my life. After my life time, my wife will also be eligible for the monthly payment
• In addition there will be a life cover of Rs10,00,000 as well all through 17 years
• All the contributions are eligible for 80C deduction and all payouts are tax free
• The average return is 9-10% and eligible for loan facilities as well
• For Rs seven lakhs investment you can get Rs seventeen lakhs over seventeen years (Rs fifty thousand for ten years plus twelve lakhs lump sum). Or even better I can get Rs sixty lakhs over the lifetime (Rs fifty thousand for ten years plus Rs one lakh twenty thousand per year for forty years and then another Rs one lakh twenty thousand for five years for my wife after my lifetime).

In summary as per my bank advisor this is a super children’s education/wedding product and it can double up as a retirement product as well!! It’s definitely a very tempting pitch and this I am sure you would also seen similar kind of pitches from your bank Relationship Manager.

• What do you think? Is this a great plan which the bank is so generously sharing with the customers? Is there something I am missing here?
• What has the Advisor shared and what has he left out?

All this information about the great product are told but without sharing the name of the product. I have to really push the “Advisor” to be told the name as ICICI Pru Cash Advantage!

On getting the name of the product, I went through the product brochure and analyzed the cash flows as per the numbers given by the “Advisor”. Three important aspects which caught my eye are expected return on investment, guaranteed surrender value, and the surrender value on discontinuance.

Expected returns from the policy

It is interesting to note that the cash flows are not very different to what the Advisor had given us but for one key difference.
• The final bonus of 9.31 lakhs was based on assured returns of 8%
• For assured returns of 4% the bonus drops by a whopping 82% from 9.31 lakhs to 1.6 lakhs!
What is interesting is that traditionally the bonus declared by the Insurer has been between 4-5%. So how on earth they are going to make 8% assured returns?
Guaranteed Maturity Benefit

The policy terms and conditions clearly states that the guaranteed maturity benefit is only 100.1% of all premiums paid. So there is no guarantee that you would get 8% or 9% returns on this product.

Surrender value if I don’t make payments for all seven years

I should have made at least two payments (three for a ten year policy) to be eligible for any surrender value. So If I took a ten year policy and I am not able to make three payments, then the value of the policy is ZERO!
If I choose to discontinue the policy, I will be entitled to the surrender value which is the higher of (below text reproduced verbatim from the product document)

As per the product brochure, the guaranteed surrender value factor ranges from 45% (2 to 3 years) to 75% (8th year onwards). Please deduct another 5% if I am above 45 years at that time. And god forbid, after making two years of payment, I am unable to pay for the third year, my entire money goes down the drain !
While the product can be analyzed in more detail and various other challenges can be found out, it is a deadly combination of low returns + poor liquidity + lack of flexibility.

How does it compare with a plain vanilla PPF & Equity Mutual Funds?

Just for the comparison sake, we thought of investing the same corpus of Rs98,000 per year (after deducting mortality charges of Rs2,000) for the next 7 years in a combination of PPF and Equity Mutual Funds, split equally. The expected cash flows after 17 years would be Rs24.85 lakhs, which is higher by Rs5.32 lakhs than that of ICICI Cash Advantage would provide. We have assumed the PPF return at 8.70% and Equity return at 12% over the next 17 years, which I think is reasonable.

I strongly suggest avoiding such products and investing in simple products with clear risk return expectations for the long term. I believe any financial investment for the long term should be evaluated based on the following 5 principles, before you decide to commit yourself to it:
• Is it flexible enough so that I can increase or decrease the investments year on year?
• Does it provide reasonable returns for the risk assumed?
• Are the exit options are easy and simple?
• Would the investment be able to provide tax efficient returns?
• Is the product is suitable for the goal I am investing for?

This particular insurance scheme ticks couple of boxes in the above list but not all. It doesn’t provide easy exit, no flexibility on the investment amount and not suitable for a long term goal like Child’s education or daughters marriage. I would not touch this product with a barge pole for my long term goals. I would definitely see a need to allocate a good portion of my investments in Equities/Equities oriented product for any long term goal.

We would be glad to have a detailed discussion on what would fit your needs. And would also love to hear more from you about such products!