Wednesday, December 06, 2006

Tips for buying Insurance (Part I)

Each person's requirement is different. With so many companies and so many products available, the selection of the right policy could be difficult. One needs to spend time to identify what their primary requirement is and then select a policy which meets your requirement. The following are some of the factors that one should consider prior to selecting an insurance policy.

High Sum Assured with small premium
If your requirement is buying a policy which offers maximum cover with minimum premium, the "Term Plan" best suits your needs. Please be aware that with term insurance you don't get anything back. Kotak offers one of the best term plan for non smokers. You might also want to get the quotes for term insurance from other companies like LIC, ICICI and HDFC and checkout which term plan works out to be the best.

Maximum Term
If your priority is to have insurance cover for the rest of your life without any age restrictions, then "Whole Life" ULIPS should suit you best. There are ULIPS from Metlife, LIC which offer insurance cover for the rest of ones life without any age restrictions. You might also want to check with other insurance companies if they offer Whole Life ULIPS.

Maximum Insurance Cover with Returns
If ones priority is to get maximum insurance cover with the option that you get decent returns at the end of the term, then the best plan for you is regular ULIPS. You might want to get quotes from Reliance, Bajaj Allianz, ICICI which offer sum assured of 100 times the premium.

Childrens Education
If one is looking for an insurance product for saving towards their "Childs Education/Marriage" then I would recommend Children's ULIPS. I would recommend getting quotes for HDFC Young Star and ICICI Smart Kid or a children's ULIP from any company. In my opinion, these are very well designed ULIPS which offer excellent security for your kids future. Incase anything unfortunate happens to the proposer, these plans offer immediate "Sum Assured" to the beneficiary. The company also pays the balance remaining premiums towards your kids education. On maturatiy or whenever the need arises, the kid is entitled to all the funds contributed by the proposer and also to the funds contributed by the insurance company. (If it is for your Children's future, please donot go for anything less than a Children's ULIP. You might run into insurance agents who might be selling you regular ULIPS for your kids education but this in my opinion is a bad deal!).

Guaranteed Returns
If ones priority is "some guarantee on returns" rather than maximizing returns, then one should opt for traditional endowment plan from LIC. These plans guarantee the "Sum Assured". But please be aware that traditional endowment plans are not flexible like ULIPS and might not yield as much returns. There are also some ULIPS which guarantee the premiums paid and with the added benefit of investing in equities for maximizing returns like Kotak Safe Investment Plan 2.

Investments/Maximizing Returns
If ones priority is mainly investments/"return on investment" with decent insurance cover, then one needs to opt for a good ULIP with less charges and good returns. I would recommend getting quotes from SBI, HDFC. These have been the top performers among ULIPS and have been yielding good returns (better than many MF's).

No one product will suit the needs of every person. One will need to identify what his priorities/needs are and then select a product that will meet his needs.

Sunday, October 29, 2006

Why it is important to examine all products offered by an insurance company before buying one

In todays market, you have different products offered by the same company. Some of these products are designed with the investor in mind and to provide maximum benefit to the Investor whereas some of products are designed to rob the Investor for the benefit of the insurance agent and the insurance company. I have used a strong word ROB because that is what some of the products actually do. To explain the relevance of my earlier statement, I would like to compare two different ULIPS offered by Bajaj Allianz

Policy NamePolicy Admin ChargeInitial Loading Charge
New Unit GainRs.600 per annum71.5% first year
New Unit Gain PlusRs.240 per annum24% first year

Clearly, the charges in "New Unit Gain" are significantly higher than "New Unit Gain Plus". I checked to see if New Unit Gain offers any additional benefits to justify the higher charges. You will be suprised that "New Unit Gain" does not offer any additional benefit to justify these additional charges over "New Unit Gain Plus".

Very recently my co-worker was asked to take "New Unit Gain" policy by his insurance agent. He was not even told about "New Unit Gain Plus". The incentive for the agent to sell "New Unit Gain" is because he gets higher commision. I had a similar experience in the past with ICICI. The agent kept offering me "Lifetime" while "Lifetime II" was a much better product.

It is sad when insurance companies resort to such tactics to exploit the ignorance of thier customers for their own benefit. They should be more proactive in "stopping sale off" older products(like LIC) once they have launched newer/better products.

Donot leave it to the insurance agent to identify the product that best suits your needs. I have come across many insurance agents who are more interested in thier commission than your interests. So do your home work before buying a policy. Visit the website of the insurance company and download the brochures of the different products they offer and spend some time reading them. If you can't seem to understand the brochures, you might want to visit forums/blogsites (like to get the opinion of others.

Wednesday, October 25, 2006

Have a question about Insurance/ULIPS??

If any of you have any questions related to insurance that you would like my views on, please feel free to ask.

Monday, October 09, 2006

Risk Management: Allocation of funds to equity and debt

I am sure many of you might have wondered how much exposure to equity is safe at any point of time. I am suggesting two methods, one based on weighted average PE Ratio of Nifty or Sensex, and the second based on term of the policy.

Fund Allocation Based on Nifty/Sensex PE Ratio
In this approach, I decide my allocations to equity and debt based on weighted average PE Ratio of Nifty or Sensex. At higher PE Ratio levels, I advise reducing your exposure to equity. Similarly at lower PE Ratio levels increase your exposure to equity. You will be able to find weighted average PE Ratio of Nifty or Sensex at or The reasoning behind this approach is we have lesser exposure to equity when we think the market is expensive. We have more exposure to equity when the market is cheap. The following is the asset allocation I would suggest based on PE Ratios.

PE RatioEquity Exposure %Debt Exposure %
Below 1390 - 1000 - 10
13 - 1670 - 9010 - 30
16 - 2050 - 7030 - 50
20 - 2420 - 5050 - 80
Above 240 - 2080 - 100

Fund Allocation based on the Term to Maturity
This approach is applicable to goal based investing, example planning for children's marriage. In this approach we decide asset allocation ratios based on the term remaining till goal or maturity. The longer the term to maturity in years, the higher the exposure to equity. The idea behind this approach is that we take higher risk when we have more time on our side. We take less risk if the by when we need to funds is less.

Term Left from GoalEquity Exposure %Debt Exposure %
Less than 3 years0 - 2080 - 100
3 - 6 Years20 - 5050 - 80
6 - 10 Years50 - 8020 - 50
More than 10 years80 - 1000 - 20

Saturday, October 07, 2006

Which charges have the biggest impact on returns

I have been trying to measure the impact of the following charges on overall returns
  • Loading Charges
  • Admin Charges
  • Fund Management Charges

I have used the following three plans in my comparision.
  • Bajaj Allianz Unit Gain Plus
  • HDFC UnitLinked Endowment Plus
  • ICICI Lifetime Plus

Loading Charges
HDFC - 60% first year
Bajaj- 24% first year
ICICI- 25% first year

Admin Charges
HDFC - Rs.240 per annum
Bajaj- Rs.240 per annum
ICICI- Rs.720 per annum

Fund Management Charge
HDFC - 0.80%
BAJAJ- 1.75%
ICICI- 1.50%

For an Investment amount of Rs.24,000 per annum assuming an annual return on investment of 10%, the following is how the returns look like

Investment Time Frame - 5 Years
Best Returns - BAJAJ (7% more than ICICI)
Second Best - HDFC (2% more than ICICI)
Last - ICICI

Investment Time Frame - 10 Years
Best Returns - HDFC (5% more than ICICI)
Second Best - BAJAJ (3% more than ICICI)
Last - ICICI

Investment Time Frame - 15 Years
Best Returns - HDFC (8% more than ICICI)
Second Best - BAJAJ (1% more than ICICI)
Last - ICICI

Investment Time Frame - 20 Years
Best Returns - HDFC (12% more than BAJAJ)
Second Best - ICICI (0.5% more than BAJAJ)
Last - BAJAJ

Investment Time Frame - 25 Years
Best Returns - HDFC (16% more than BAJAJ)
Second Best - ICICI (2% more than BAJAJ)
Last - BAJAJ

For an investment time frame of 5 years, Bajaj Allianz Unit Gain Plus seems to offer the best returns. For any investment time frame of 10 years to 25 years, HDFC seems to offer the best returns.

Regarding charges, on the long run, Fund Management Charges have the most significant impact on performance. You will notice the gap in returns between HDFC and other widening as time passes(inspite of 60% loading charge). This is because it has the least FMC. Even ICICI which offer slightly better fund FMC than Bajaj has been able to surpass the returns of Bajaj Allianz Unit gain plus on the long run.

Fund Management charges are the most important charges for long term investments. Chose a ULIP product that has the least fund management charge to maximize your returns.

Sunday, September 24, 2006

Why one should avoid traditional endowment plans

Just wanted to illustrate with this example why Term + PPF is better than LIC guaranteed return endowment policies (or) any traditional endowment policy from any company.

In the below example, I am comparing the returns from Komal Jeevan(which guarantees 7.5% per annum bonus) against term insurance plan(for insurance) and PPF(for investments). The plans are for a 30 year old male for a sum assured of Rs.5,00,000.

Komal Jeevan Plan
Sum Assured: Rs.500,000/-
Yearly Premium: Rs.37,177/-
Total Premium Paid in 18 years: Rs.6.69 Lakhs.
Returns by the end of 26 years: Rs.14.75 Lakhs.

Term + PPF:
Sum Assured: Rs.500,000/-
HDFC SL Term Insurance Yearly Premium: Rs.1,600/-
PPF Investment Yearly: Rs.35,577/-
Total Investment(PPF + Term Insurance): Rs.37,177/-
Total Premium Paid in 18 years: Rs.6.69 Lakhs.
Returns by the end of 26 years (8% PPF returns): Rs.26.63 Lakhs.
Percentage of investment that is used to pay term insurance: 4.3% per year.

Returns from Komal Jeevan which gives Rs.37,500 bonus per year is lot less than what you get back from PPF.The reason for this is quiet simple. Endowment Plans gives bonus based on the sum assured. Your returns each year is the same irrespective of your investment. In an endowment plan there is no compounding effect on your investment, interest. Hence the returns are very low. On the other hand, investments in PPF which is guaranteed by Government of India gives 8% returns compounded annualy. The power of compounding is immense, hence your returns are almost double than what you get from an endowment plan. Even if you invest in avenues which offer compund interest of 5%(like bank FDs, RDs), you will get back Rs.15.5 Lakhs at the end of 26 years.

Lesson 1 for an Investor: Power of Compounding
Compound Interest of 5% per annum will give higher returns than bonus of Rs.75 per thousand. Please donot be tricked by LIC agents who say 7.5% bonus has been declared for that year. Bonus is purely on sum assured and not on your investment. Only invest in avenues where your returns are compounded. Stay away from traditional endowment plans. These plans are the most beneficial to the insurance agent(in terms of commision received) but are not the best plans for the investor.

Lesson 2 for an Investor: Understand your charges properly
Insurance agents use the terms 80% charges on endowment plans is better than 100% charges on term insurance. But are you really paying 100% charges on term insurance. From the above example
100 % Charges for Term Insurance = Rs.1,600/-
80% charges on Endowment Plan = Rs.29,741/-
One is paying Rs.1600 charges in term insurance while paying Rs.29,741 as charges in endowment plan the first year. But how come insurance agents say paying Rs.1600(100% charges) is worse than paying Rs.29,741(80% charges). In reality, the actual percantages are different. The total percentage of your investment that you pay for term insurance charges is just 4.3%(Rs.1600 out of total investment of Rs.37,177). The insurance agents hide the overall picture. It is your duty,the duty of the investor to understand the overall picture of charges.

Lesson 3 for an Investor: It is your Money!
What ever you invest is your money so understand where you are putting your money. Donot rush into something because someone else said so. Donot buy LIC plan just because your father said it is the oldest insurance company, most profitable and hence will offer the best returns. Do your home work. Explore all possible avenues of investment. Understand the product where you want to invest. Understand the charges, returns and also RISKS. This is no Rocket Science. All you need is pure common sense to understand most of the products. It is your hard earned money. A rupee saved is a rupee earned.

Friday, September 22, 2006

Comparision of ULIPS vs MFS (India)

Below is a brief comparision of ULIP (Unit Linked Insurance Product) vs MF (Mutual Funds) specific to the Indian market.

Primary Objective
MFs : Investments
ULIPs: Protection + Investments

Investment Duration
MFs: Works out for Medium term, Long Term Investors. Risky for Short Term investors.
ULIPs: Works out for Long Term Investors only.

MFs: Very flexible. Plenty of scope to correct your mistakes if you made any wrong investment decisions. You can easily shuffle your portfolio in MFs.
ULIPs: Flexibility is limited to moving across the different funds offered with your policy. Correcting mistakes can turn out to be expensive. Moving funds from one ULIP to an other ULIP of a different fund house can be expensive.

MFs: Very liquid. You can sell your MF units any time(except ELSS). Some MF's like those from Reliance have introduced redemptions at ATMs.
ULIPs: Limited liquidity. Need to stay invested for the minimum number of years specified before you can redeem.

Investment Objective
MFs: MF's can be used as your vechile for investments to achive different objectives.(Eg: Buying a car three years from now. Downpayment for a home five years from now. Childrens education 10 years from now. Childrens marriage 15 years from now. Retirement planning 25 years from now. Medical expenses after retirement 25 years from now)
ULIPs: ULIPs can be used for achieving only long term objectives (Chidrens education, Childrens marriage, Retirement planning)

Tax Implications
MFs: All investments in MF's don't qualify for section 80C. Only investments in ELSS qualify for 80C.
ULIPs: Provide Tax Benefits under section 80C.
MFs: Returns on equity MF's are exempt from long term capital gains tax. (Unless tax laws change in the future).
ULIPs: We are moving from EEE to EET. No clarity if ULIPs will be taxed under EET.
MFs: Tax liabilities when moving across from debt to equity funds.(Returns from debt MF's are taxed.)
ULIPs: Very flexible in moving between equity and debt funds(not tax implications until maturity of the policy).

Strings Attached(fine print)
MFs: None so ever. At most you pay a small exit load if any.
ULIPs: Some strings attached for your policy to be in effect. Minimum number of premiums need to be paid. Minimum fund balance need to be always maintained. (I personally donot like policies which say pay three years premium and get insurance cover for the next 25 years since there are a lot of ifs and butts involved. A lot of assumptions made and nothing is in your hand, it could turn out your fund balance might be exhausted after just 12 years of insurance cover).

  1. Can easily rebalance your risk between equity and debt without any tax implications.
  2. Best suited for medium risk taking individuals who wish to invest in equity and debt funds(atleast 40% or higher exposure to debt).
  3. No additional tax burden for those investing mainly in debt unlike in MFs.
  1. Better returns than ULIPs.
  2. Lower charges than ULIPs.
  3. Very flexible and enables you to switch your investments from non performing MF's to better performing MFs
  4. Very Liquid can be redeemed at anytime.
  5. Best suited for medium to high risk taking individuals who wish to invest a significant portion in equity funds(atleast 65% exposure in equities).