How Rs 3.2 lacs became Rs 11,678 in 6 years?

The birth of a child brings joy not only to the parents but also to the parents of the parents i.e. grandparents.  It is not uncommon to see grandparents making an investment in the name of their grandchildren. They want to contribute towards their grand children’s future.

In this post, I will pick a case where a senior citizen picked up an investment product and invested approximately Rs 3.2 lacs over 6 years. He ended up with a princely sum of Rs 11,678.

Shocked? Well, I am not making up the numbers. This is a true account.

How did this happen?

How Rs 3.2 lacs became Rs 11,678 in 6 years?

By the way, he didn’t invest in a penny stock. He merely purchased a child plan from an insurance company.

He purchased (or was sold) HDFC Life Young Star Policy for Sum Assured of Rs 2.5 lacs with a quarterly premium of Rs 12,500. He paid the premium of Rs 3.2 lacs in 6.25 years. When the policy was closed by the insurance company, he got a princely sum of Rs 11,678.

I came across this case in an article in an old edition of Money Life magazine and have relied on the information shared in the post.

What went wrong?

A life insurance plan cannot be without an element of life insurance. And a ULIP is a life insurance plan. Therefore, you must incur the cost for life insurance too (in the form of mortality charges). By the way, under a term life insurance plan, you pay only the mortality charges since there is no investment angle.

In any ULIP (unit-linked insurance plan), the mortality charges are recovered by canceling units from your holdings (Wealth) to recover the charges. And that affects your returns. The older you are, the more you must pay for the life cover. To put in a different way, the older you are, greater the number of units that need to be sold to recover mortality charges.

In any investment and insurance combo product such as a ULIP or an endowment plans, your age will affect your returns.

Let’s look at the reasons.

Read: How various charges in ULIPs affect your returns?

Mortality Charges increase with age

Quite clearly, if the mortality charges are higher, a greater number of units will have to be liquidated to recover mortality charges. And mortality charges will increase as you grow older. Why?  The probability of a 65-year-old dying in the next 1 year is much higher than the probability of a 25-year old dying in the next year.

A serious illness can increase mortality charges further.

In this specific case, the consumer had a coronary heart disease, which resulted in the doubling of mortality charges. The reason is that the chances of the demise of the policyholder are higher because of the illness.

Nature of child plans

The nature of child plans is such that in the event of the death of the policyholder, the future premiums are paid by the insurance company. This rider is commonly known as the waiver of premium rider.  By purchasing this rider, you ensure that the investments for your child’s future continue in your absence. Noble thought per se.

However, in this specific case, since the applicant was a senior citizen, this rider came at a high cost. Essentially, it will increase mortality charges even further.

Intermediary Commissions

This is an old case. The policy was sold in 2006. At the time, agent commissions in ULIPs were very high. That would have also eaten into the corpus.

With revised ULIP guidelines, the commissions have been capped. Hence, this is no longer as big a problem. Since the commissions are capped in ULIPs, the banks and insurance agents have shunned ULIPs these days and started selling traditional plans because traditional plans still offer high commissions.

Going by MoneyLife article, Rs 41,000 out of annual premium of Rs 50,000 (Rs 12,500 X 4) went towards mortality charges (life insurance cover).  Hardly anything left for investment.

And that’s how an investment of Rs 3.2 lacs became Rs 11,678 in 6.25 years.

Must Read: Which is the best term insurance plan for you?

Where is the responsibility of the agent or insurance company?

This is a classic case of mis-selling. 

This is similar to a case where an investment of Rs 50,000 in an insurance plan from SBI Life became Rs 248 in five years. Read more about the case here.

Did the agent not know that the mortality charges will eat heavily into returns? Perhaps not. Ignorance is not innocence but we must extend the benefit of doubt.

Did the underwriting team of the insurance company not know? They surely did. The underwriting team can’t be given benefit of doubt. Even if the process is automated, such proposals should be red-flagged.

Nobody cared to inform the old man what he was getting into. His investment was doomed since the day he purchased the plan.  The unfortunate part is that the insurance agent and the insurance company didn’t do anything.

If he knew almost 80% of his annual investment will go towards life cover (that perhaps he didn’t even need), would he have purchased the plan? I am quite sure he would have stayed away.

I just wonder if the transaction took place at a branch of HDFC Bank. There is no such mention in the MoneyLife article. Hence, it will be prudent to give HDFC Bank the benefit of doubt. However, the bankers typically do not have any qualms in selling the most inappropriate products to their customers.

For all you know, the gentleman may have walked into the bank branch just to open an FD or a recurring deposit for his grandchild. And banks do not let you open FD so easily these days. You can read about the experience of one of my clients when he walked into a bank branch for opening a PPF account in this post.

What should you do?

1. Do not mix investment and insurance.
2. Assess if you need a life cover. You may not need life insurance during retirement.
3. Develop greater awareness about financial products. Do not trust anyone. Look into a potential conflict of interest. You need to be aware to ask the right kind of questions. If you rely too much on others, you will be taken for a ride sooner or later.
4. Keep track of your investments: If the policyholder had kept track of growth in investment corpus, he would have realized that something was wrong quite early.
5. Do not fall for fancy product names. Do not fall for emotional sale pitches. Make a rational and objective decision.
6. Do not visit a bank for seeking investment advice. I have said this many times before. Most bank officials are not well trained. Even if they are trained well, they are trained well in making sales and earning commissions for the banks. The bank officials never pay any heed to your requirements. You are better off going to a casino and gamble your money away.  It will give you a greater thrill now and less heartburn later.
7. Seek professional advice, if required. When it comes to financial products, it seems everybody is an expert. Nobody holds back in offering unsolicited advice when it comes to investments. Seek professional advice from a SEBI Registered Investment Advisor. You might have to pay a fee. However, the cost of purchasing a poor financial product is much higher than the fee that you pay to an advisor.

Additional Read

1. MoneyLife Article
2. After tax on LTCG on equity funds, are ULIPs better than mutual funds?
3. How (not) to invest for Children’s Education?
4. Do’s and Don’ts while planning for children’s future
5. How to select the best ULIP for your portfolio?
6. No parent should purchase LIC Jeevan Tarun
7. Don’t invest in LIC New Children’s Money Back plan

The article was originally published in August, 2016.