Even decent investment products can be mis-sold.
Better explained with an example. A Nifty index fund is a low-cost equity product. Difficult to find flaws. However, if it is sold as a short-term investment for a goal 2 months away, it is mis-selling.
Note: This post is for education and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The products quoted are for illustration only and are not recommendatory. Read and understand the product terms and conditions and consider suitability before investing in any investment product.
Came across a similar issue with an annuity product from a prominent insurance company.
Annuity plans from insurance companies can be useful income products provided you buy the right variant at the right age. You can lock in the interest rate for life. You can’t do that with any other investment product. You can stagger annuity purchases to increase income and reduce risk during retirement.
An investor received the following message.
Good News!! You wanted it & we have revised our deferred annuity rates only for you. You can now get a guaranteed 12.3 % annuity with a one-time contribution. Invest Rs 1cr once & get Rs 12,28,634 p.a. for life + Return of investment in ICICI Pru Guaranteed Pension Plan – Deferred Annuity.
These days, when senior citizen bank fixed deposits are yielding 7-8% p.a., guaranteed 12.3% p.a. for life is an excellent return.
But there is a catch.
And it is not difficult to see where the catch is
The promotion is for a deferred annuity plan.
There are two types of annuity plans.
- Immediate annuity plans: Pension income starts right away. LIC New Jeevan Akshay is a popular product in this space.
- Deferred annuity plans: The pension income does not start right away. It starts after a few years. LIC New Jeevan Shanti is a popular deferred annuity plan.
It is clearly mentioned in the message that the plan is a Deferred annuity plan.
If you invest Rs 1 crore and start getting Rs 12 lacs from the first year until demise (and the family gets back the purchase amount in the event of demise), then you can say that the return is 12% p.a.
However, if you invest Rs 1 crore but the pension income for life starts after 10 years (the family still gets back the purchase amount after investor demise), then the return is obviously not 12% p.a.
Let’s see how.
Let’s say you have Rs 1 crore, and you invest in a product that offers 6% post-tax. In the next 10 years, this corpus will grow to Rs 1.79 crores.
For a corpus of Rs 1.79 crores to generate an income of Rs 12 lacs per annum, you need a return of just 6.7% p.a. And this 6.7% can be pre-tax (since annuity income is taxable).
So, we are talking about returns of about 6-7% all the time. And you can earn a similar return in a bank fixed deposit too. Where is the 12.3% that the promotion mentioned?
Note: With bank FDs, you can’t lock in interest rates for life. Hence, not exactly an apples-to-apples comparison.
Mentioning 12.3% is a trick to attract investors. And the insurer knows it. Yes, you get 12.3 lacs per annum on investment of Rs 1 crore but this income starts after 10 years. What about the time value of money?
*Annuity purchases are subject to GST of 1.8%. Hence, while your pension income is calculated on Rs 1 crore, you will have to pay Rs 1 crore + 1.8% = Rs 1.018 crores
ICICI Pru Guaranteed Pension Plan
- Available under both Immediate and Deferred Annuity variants.
- The promotion was about deferred annuity variant. Hence, would focus on deferred annuity variant only in this post.
- Option to defer annuity income for up to 10 years.
- The deferred annuity variant is available only WITH return of purchase price variant i.e., in the event of demise of the investor (annuitant), the nominee gets the purchase price back.
- Can be bought for single life or for joint life. Under joint life option, the pension is paid until either of the annuity is alive.
- The death benefit can be higher than the purchase price.
You will find these features in any deferred annuity plan.
Where is the improper communication?
- 12.3% is just not done. In no scenario, does the plan return 12.3%.
- The plan offers a deferral period of 1 to 10 years. The pension is not same for all deferral periods. Expectedly, lower the deferral period, lower the pension.
- I checked the annuity amounts for various deferral periods for a 64-year-old investor. For deferral period of 1 year, the pension amount was 6.89 lacs. For deferral of 5 years, the pension amount was Rs 9.38 lacs. For 10 years, it was Rs 12.29 lacs (and this was mentioned in the promotion)
- I calculated the IRRs too (for 64-year-old investor at entry). With annuity plans, everything is known upfront except the date of investor demise. I calculated the IRR for various demise ages.
Demise at the age of 80 would result in an IRR of 5.33% p.a.
4.82% if the investor passes away at the age of 85.
5.42% if the investor passes away at the age of 90.
6% if the investor passes away at the age of 100.
Nowhere close to 12.3% mentioned in the promotion.
What should you do?
Nothing wrong with this plan. It is a deferred annuity plan. If a deferred annuity plan fits with your financial plan, this plan can be part of your consideration set just like any other deferred annuity plan.
I do not look at annuity products purely from the point of view of XIRR. We must also appreciate these products for the peace of mind these can provide.
For instance, a 50-year-old without a pensionable job is looking for a simple product to generate low-risk income after he/she retires at the of 60. Not investment savvy. Not really looking for great returns. The focus is not to optimize returns. Just peace of mind that there will be guaranteed income for life during retirement. Such investors can find deferred annuity plans attractive. Put Rs X per annum for 10 years and get Rs Y per month for life. Can there be a simpler product?
However, the key is not to fall for misleading communication. Understand the product properly before investing.
When I first saw the message (for a return of purchase price product), it was obvious to me that 12.3% p.a. couldn’t be true. The number had been deliberately thrown in to mislead investors. Perhaps, I am being too harsh. Guess that’s the way product sales work.
My problem is: Not everyone understands or can do the math. 6% return may be an acceptable return to a particular investor. But that investor should not buy a 6% return product thinking it offers 12%.
Similarly, when an insurance company or an agent tries to sell a 6% product while giving impression that it offers 12%, it is mis-selling.
By the way, such mis-selling is not limited to a insurance products. Happens with mutual funds too.
Insurance companies, AMCs or financial services intermediaries will do what they do. As an investor, you must be cautious.
Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market is subject to market risks. Read all the related documents carefully before investing.
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