Highest nav plan doesn?t guarantee highest return

As human beings. we like assurances in all aspects of life. This is where guarantee plays its part; more so, when it comes in terms of return. And this was what Sunil Vyas was discussing with his wife, Anu. Since the 2008 downturn and with continued volatility in the economic environment, Sunil wanted the security of assured returns. While scanning financial papers, Sunil had come across the highest NAV guaranteed plans. It intrigued him that, on maturity, he would receive a guaranteed sum, which has been mentioned at the beginning of the term. Sunil sought out an advisor, Sachin Nayar, who unravelled the workings behind the product.

In a highest NAV guaranteed plan, the insurer promises to pay a highest-attained NAV by the plan (typically of the first seven years) during the policy period. If you read more carefully, it is the highest NAV and not the highest return. So, by the very nature of the product, the return generation will be limited, as after a certain period of time, typically in the last 2-3 years of the policy term, the asset allocation could move completely towards debt, to protect the capital and give the highest guaranteed NAV. So, how is the insurer able to provide the guaranteed return?

In the initial period, at least for the first two years, the fund will have an equity overweight asset allocation. However, in the current scenario, it is doubtful that this is the case, as debt is providing a better return. When the product is launched, the NAV is at R10. Say at the end of the third year, the NAV moves up to R14, which is the highest NAV attained till date.

Now, the insurance company has to pay NAV of R14, guaranteed, on maturity (say, in year 10). So, the insurer will move an amount from the portfolio to debt instruments, which in the remaining period will at least guarantee a NAV of R14. This cycle continues and, typically, during the last leg of the investment period, one can expect asset allocation to be completely in debt instruments. This is what guarantee does ?a suboptimal return. How? Typically, investments in equity over a period of 7-10 years should be able to generate 12-15% annualised return. Today, debt is generating a return in excess of 8-10% p.a., which may not be sustainable for long.

And apart from the typical costs a Ulip has, there is also a charge for ensuring the highest guaranteed NAV. This is known as guarantee charge, which typically could add another 0.5% of the premium cost. So, in this product, the cost are higher compared to Ulips: One would end up paying more than 10% of the premium amount as charges for the initial 2-3 years, which reduces to 5-6%, from the sixth year onwards.

As the allocable surplus to investment (after deduction of charges) is lower in the initial period, the returns will also be lower. And what about the expected return? Typically, these products are new-age products and one can expect a return of, hopefully, between 8-10%. Also, the highest guaranteed NAV is given only if the investor stays invested during the whole of the policy period.

Also, as mentioned earlier, it is the highest NAV and not the highest return that the plan gives an investor: the word ?guarantee? makes you overlook all other parameters.

* The writer is founder and managing partner of Zeus WealthWays LLP