LIC Jeevan Saral has been in the news lately for all the wrong reasons. The Supreme Court dismissed public interest litigation (PIL) filed by Money Life Foundation requesting the recall of LIC Jeevan Saral policy. By the way, the PIL was dismissed because SC opined that the Money Life foundation has no locus standi in this matter. While the last word is yet to be written in this matter, the problems with LIC Jeevan Saral are a good way to understand how traditional life insurance plan work and what factors can potentially affect your returns.
Let’s look at the issue in detail.
What went wrong with LIC Jeevan Saral?
The problem is that some of the investors have gotten less than what they invested i.e. the maturity value was less than the sum of all the premiums paid. We know that you can lose invested capital in traditional plans if you surrender early. However, most of us won’t believe that you can lose money even if you run the plan until maturity. That too for a plan from LIC. We know that traditional plans from LIC or the private insurers provide poor returns but negative returns (or loss) is still off the charts. Isn’t it? But this is exactly what happened.
Here is an excerpt from an article in Money Life magazine.
A 58-year-old person, paying half-yearly premium of Rs4,076 for 12 years, had paid a total of Rs 97,824. The maturity sum assured, which was paid to him after 12 years, was a mere Rs24,575 plus bonus, amounting to Rs34,405.
And they have highlighted many such cases in their other articles.
Why did this happen?
Under Jeevan Saral, the Sum Assured is a multiple of your monthly premium. In LIC Jeevan Saral, the Sum Assured is 250 times the monthly premium or over 20 times the annual premium. This relationship remains constant irrespective of your age.
Life cover of over 20 times annual premium is huge. From what I have read, this was a prominent sales pitch too. At the same time, the impact of mortality charges will be huge too. For many older investors, the impact of mortality charges was so huge that their returns from LIC Jeevan Saral Plan were negative.
In traditional plans and ULIPs, your age affects your returns
In any traditional life insurance plan, everything else being the same, the annual premium will increase with age. You select the Sum Assured and the policy term to calculate the premium. This is best understood with the help of an example.
Annual Premium for LIC New Jeevan Anand for Rs 10 lacs Sum Assured for a policy term of 20 years will be ~Rs 55,000 before taxes.
Annual premium for the same policy for a 50-year-old will be ~Rs 70,000 per annum.
Now, the bonuses under LIC New Jeevan Anand do not depend on the age, but on the Sum Assured and the policy term. Therefore, the two policyholders will get the same maturity value. However, the older person paid a much higher premium for the same maturity value. Hence, the net returns (IRR) for the older investor will be lower.
Why does this happen?
This happens because the insurance company charges more to provide life cover to the older person. Though these calculations are not explicit, the provision for higher mortality charges is built into the higher annual premium.
This happens for all investment and insurance combo products. It happens in ULIPs too. However, it works in a different way in ULIPs. The higher mortality charges are not built into a higher premium. The mortality charges are settled by liquidating the fund units. Higher your age, higher the mortality charges, greater the number of units to be liquidated to recover charges, lower the returns. Though the path may be different, this relationship will hold for all investment and insurance products.
I have discussed this aspect in great detail in this post.
What are the other problems with LIC Jeevan Saral?
In all the plans, LIC mentions Base Sum Assured. The nominee gets the Base Sum Assured (plus bonuses or loyalty additions, if any) in the event of the demise of the policyholder. If the policyholder survives the policy term, the policyholder is paid Sum Assured + Bonuses (or loyalty additions), if any. Therefore, even in the worst-case scenario, you or your nominee will at least get back the Sum Assured amount.
Essentially, there is just one Sum Assured. Both death benefit and the maturity benefit are linked to it.
No such thing in LIC Jeevan Saral.
LIC Jeevan Saral has this concept of Death Sum Assured and Maturity Sum Assured. I have read that, in some of the policy documents, the Maturity Sum Assured was blank or the value of Death Sum Assured was copied in the Maturity Sum Assured field, giving the wrong impression to the buyers. This leaves LIC open to a few lawsuits. In my opinion, this is more of a technicality.
In this post, I want to comment about the structure so that we can avoid such mistakes in the future.
Who is at fault?
I do not know of the promises that were made during the product sales. I have read that even some of the agents are surprised that the policy has earned negative returns.
We can question the competence and intention of LIC or the agents who sold such policies to older investors. At the same time, investors must share some blame too. They must have understood the product better.
By the way, LIC Jeevan Saral will not provide negative returns for all the investors. The negative returns are more likely for older investors. For the others, the returns will be poor and in single digits, as with the other traditional plans.
I checked the LIC Jeevan Saral calculator on this website. While I don’t want to get into the assumptions used or if the calculations are correct, the returns go negative once the entry age goes above 50 (for 10-year policy term). I have not considered any riders, which will reduce the age at which the returns go negative.
A 25-year-old investing Rs 1.2 lacs per annum (Death Sum Assured of Rs 25 lacs) in this plan for a policy term of 10 years would have earned about 5.5% p.a. Not good but in line with what you typically earn in a traditional life insurance plan. Therefore, a lot depends on the entry age.
A 35-year-old would have earned about 5.1% p.a.
A 45-year-old would have earned 3.1% p.a.
A 55-year-old would have earned -4% p.a. This investor will get back about Rs 9.6 lacs on total premiums of about 12 lacs.
In my opinion, there is nothing wrong if an insurance product provides negative returns (or if you get less than the premium that you paid). After all, in term insurance, you get nothing back and yet we don’t complain. LIC Jeevan Saral provided a higher life insurance cover as compared to other traditional life insurance plans and that lead to negative returns for older investors.
The fault lies in setting the wrong expectations. And for this, LIC and the sales agents are at fault. The fault lies in not appreciating the effect of higher life cover on the maturity amount. It is possible that the LIC team was optimistic about its future performance when it sold the plan. However, it is not that -4% would have become +4% because of LIC’s good performance. This is something the LIC actuaries or the product team should have been aware of. If they weren’t aware, they don’t deserve to be in their positions. If they were aware, they should have informed the agents about it and put entry age restrictions or provide suitable disclosures in their advertisement. If LIC was aware and did not pass this on to the agents, LIC can be accused of mis-selling. If LIC informed the agents and the agents still sold to older clients, then the agents can be accused of mis-selling.
What should you do?
There is nothing wrong in desiring a higher life cover from life insurance cover. However, don’t do this in a life insurance policy which also has an investment angle (traditional plans and ULIPs). A very high life cover (as a multiple of annual premium) in such plans will be detrimental to returns from the plan. Income Tax laws permit your insurance proceeds to be exempt from tax as long as the minimum death benefit is at least 10 times the annualized premium. Therefore, that is a good benchmark for you.
Keep things simple.
Keep insurance and investment separate.
Purchase a term insurance plan and invest in pure investment products.
You will not only get higher coverage at a cheaper cost but will also likely earn better returns.