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Please read the insurance terminology very carefully

Sanjay Matai

Sometime back I received an email from one of my acquaintances seeking my opinion on a particular insurance policy.

"Hi Sanjay,
Attached is the file sent by ****** who are selling this product. Pls advise if suitable. It gives 7.5% assured return, plus 6 to 10% additional, complete total amount is tax free. If ok, then i intend to invest about Rs. 2 lakhs p.a.
tks n regards."

On the face of it, it looked too good to be true. However, when I went into the details of the Plan, I realised that the terms used by the insurance company had a somewhat different connotation which required that you read the details very carefully. Otherwise you could totally misunderstand the product.

Now, this particular person is a well-informed investor. So I was wondering that if he could misunderstand the policy terms, then it would be too much to expect for an average investor to understand the policy and take an informed decision.

The policy required that he pay the premium for 7 years. Then he would get a “guaranteed 212.5% returns over a period from 8th to the 22nd year” comprising 7.5% of the sum assured from the 8th to the 22nd year plus 100% of the sum assured on policy maturity in the 22nd year.

In value terms, as per the illustration given to him, it showed that he would have to pay Rs.2 lakhs as premium from Year 1 to Year 7. He would start receiving guaranteed Rs.62,404 from Year 8 to Year 22 plus Rs.8,32,051 at policy maturity in Year 22. (Meanwhile, his sum assured would be Rs.8,32,051 which would be paid to his nominee in case he died before policy maturity.)

[Of course, depending on the actual performance of the fund, a higher amount would be payable. In this regard, calculations were worked out if the fund earned 6% and 10% returns. However, for the present article, we will ignore this.]

Here's what I realised. The guaranteed 212.5% returns comprising 7.5% for 15 years (=112.5%) plus 100% at maturity are NOT the return that we understand in the normal parlance. It is NOT the return on OUR INVESTMENT (in this case Rs.14 lakhs – premium of Rs.2 lakhs paid for 7 years). If you read carefully, it is 7.5% of the SUM ASSURED. In this case it is 7.5% of Rs.8.32 lakhs i.e. Rs.62,404. Now in actual terms Rs.62,404 on Rs.14 lakhs works out to just 4.46%.

This is where my friend and most people go wrong and misunderstand the terms. When they hear 7.5% returns, they assume it is like in the FDs i.e. 7.5% on the amount deposited. But in this case it is 7.5% on a totally different figure and not the total premiums paid by you.

But wait! This is not the end of the story.

This payment of Rs.62,404 per year was to begin only from Year 8. In other words, there were to be no returns for first 7 years. Therefore, the effective guaranteed return over 21 years worked out to ONLY 1.66%. Yes, that's right - the effective guaranteed return on investment was just Rs.1.66% and not 7.5% as people usually tend to wrongly believe.

My contention is why use the word 'return', which can be easily misunderstood as return on one's investment.

I hope IRDA and insurance companies make sincere efforts to simply the language so that there is no scope for such ambiguities.

Sanjay Matai is a personal finance advisor (www.wealtharchitects.in) and author. ‘Millionaires don’t eat cakes…they make them’ is his latest publication.

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