15 September, 2015

Term insurance plans with extra benefits

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Insurance is for providing security against an unforeseen event. This aspect has long been forgotten in life insurance. But recently, term insurance plans have got a new lease of life though they are not very popular. Agents are not keen to sell them due to low premiums, medical requirements are high, and there are chances of rejection. But online buying is changing the game. Sensing an opportunity, many insurance companies have come out with variants of term plans which enrich the landscape of pure term plans.

Joint life term policies

Recently, companies have introduced joint life policies where both spouses are covered in a single plan. The logic: if both of them are working, they can go for one policy. Taking the policy together, however, does not confer any special benefit. The premium goes down by a small amount.

The life insurance requirements, however, can change over time. For example, the spouse may stop working and she may no longer require any life insurance. Had she taken a separate plan, she can just stop paying the premium and terminate the product. But in a joint policy, it cannot be done as the husband, would still need the cover. It, therefore, has to be retained and unnecessary premiums need to be paid.

In the unfortunate event of separation, this policy cannot be split. One may have to close this policy and take up a new one, which is probably not the best option. This product hence works emotionally and does not have a real merit.

Term plans with benefits distributed overtime

There are other variations of term insurance, which can be useful. When the insured passes away, the companies usually pay a lump sum amount to the beneficiary, which can be significant - say, Rs 1 crore. If the lump sum payment is deployed prudently, it could be useful in meeting the goals and can provide for ongoing expenses. But, this is not usually the case. Sometimes, it is frittered away in wasteful expenditure or reckless investments which can result in hardship for the family.

Now, there are policies, which in the event of death of the policy-holder, would offer a certain amount of money upfront (say 10 per cent of the sum assured) and the balance in monthly instalments over 10 years or 15 years. This could be invaluable.

In many families the male member tends to manage the finances. If he were to pass away, there would be a vacuum. In such situations, friends and relatives step in to assist the family. However, the advice offered may not always be sound and the financial well-being of the family can deteriorate.

In such a scenario, a term policy which offers staggered payments over 10 or 15 years will ensure that the family will get regular income over time. Even in a situation where the initially-available corpus is compromised and lost, the consistent income overtime will help the family to stabilise and live with dignity.

Other options

There are further variations too; such as an increasing payout every year for the agreed tenure. This is to adjust payouts to account for inflation. Then, there is an option to increase the sum assured at the predetermined occurrence of life events like marriage of the insured, arrival of a child, and so on. This would happen without medical examination, up to a particular level. The premium would be set as per the prevailing age. This could be very useful as one need not look around for another policy when the insurance need increases.

Term plans linked to child goals

Child plans have been a hit with parents as they want to ensure that the education and other goals of their children can proceed uninterrupted, even if they are no more. These policies, however, tend to be costly. Term plans have stepped into the breach and are offering similar benefits. In this, a certain portion of the sum assured (say 50 per cent) is paid in the event of death of the insured. The balance is paid on a monthly basis, at agreed levels, until the child turns 21. This would ensure that the child's education or other goal proceed uninterrupted.

The period of payout will be based on the timing of the death of the life assured. For instance, if the policy holder passes away when the child is 18 years of age, the regular payouts will only be for three years (till age 21 of the child). Hence, the monthly payout period can be much lower than in the other option discussed earlier - where one will get monthly payment consistently for 10 - 15 years. In the event the initial available money is frittered away, the regular monthly income can be for a much shorter period, which can be a problem area. Else, this is a great option and is a viable alternative to costly child plans.

Tax implications

The monthly payouts are not taxable as it is a death claim, even if it is over a period of time. Only the investment returns of any deployed amount would be taxed as applicable. There is a positive in receiving the payout over time. Since the payouts are going to come over time and most of it is going to be spent as they come, there won't be any tax liability in the future.

Insurance industry has innovated wonderfully in the term plan space. First they came up with the cheaper online term plan option. Now they have come up with a pail full of variants that have merit.

The article was published on Business Standard on 12th Sep-2015

13 September, 2015

A radical, far reaching prescription for financial services

It is no secret that financial awareness is low in our country, and many issues can be traced to this. One of this is mis-selling, which is fairly widespread because of financial illiteracy and also due to customers’ own apathy towards personal finances.
There has been some regulatory tightening to ensure that mis-selling is reduced and that customers are not taken for a ride. Now, there is a new initiative to curb mis-selling and rationalisation of incentives in financial products in the form of the Sumit Bose Committee report. The report primarily focuses on mutual funds and insurance.

If some of its provisions are implemented, it will greatly benefit the investing public. Consumers at large have been bearing the brunt of mis-selling and have lost huge sums of money in the bargain. Many people have been sold low yielding insurance policies, for every conceivable goal.

The committee report specifically dwells on what is mis-selling (which is selling a product not suitable to the customer in terms of financial situation, risk tolerance, investment objective and so on), as well as its causes. It correctly flags remuneration and how it is offered, as a cause for mis-selling. Remuneration on products alters the distributor’s behaviour in favour of pushing the one that offers the most commissions. The timing of remuneration (front-loaded or back-ended) also significantly influences distributor behaviour on product selling.
Incentive structures can also be a factor in mis-selling. The report observes that this needs to be aligned with goals and their tenors. If products offer upfront incentive for long tenored products, mis-selling can happen. Availability of multiple products with diverse incentive structures allows agents to choose one that gives them the highest commissions upfront. To modify the behaviour of agents, incentive structures and their timings needs to dovetail with customer requirements. It also specifically prohibits companies dipping into future expenses or their profit/capital.
Banks are one of the main participants of mis-selling, the report pointed out. The main problem is that banks use their clients’ privileged banking information to pitch products. This is gross misuse of information. Banks should only perform banking functions. All their product sales should be done through a completely different entity which cannot access data of banking clients. This will address the problem of misuse of privileged client information and will create a level playing field for other product sellers. The report, however, does not address this point.
The suggestions are radical in certain ways—they focus on function rather than form. Functions defined are: insurance, investment and annuity. The report suggests that the lead regulator should fix the rules of the game—the Securities and Exchange Board of India (Sebi) for investment components, Pension Fund Regulatory and Development Authority for annuities, and so on. This will ensure that there is no regulatory overlap and there is uniformity across products in terms of costs and commissions. It will also remove any future altercations on jurisdiction. This is a good way to remove regulatory arbitrage and bring the focus back to customer needs.
Another major suggestion is that the investment portion would have no upfront commissions and would follow an assets under management (AUM)-based trail model across products. Upfront commissions would stay only on the pure risk components in insurance products. This is another radical suggestion that tries to remove distributor-behaviour-distorting commissions. This would mean that insurance products will become a lot cheaper.
Flexible exit options with limited costs, too, have been suggested. Lapsation or exit costs are not to accrue to product providers. All these are lacunae in existing products the report is trying to plug.
A big problem customers face is on return expectations. The committee report suggests that returns on investment should be disclosed at the point-of-sale as a function of amount invested (as opposed to based on sum assured or premium). Also, many times, customers do not have access to important information—product costs, returns, benefits and holding period—which are usually a part of long, convoluted documents. This study, hence, suggests disclosures in a crisp form that could be understood by customers.
The importance of documenting the sale process was stressed upon. Proper documentation needs to be maintained to ensure that client goals, financial situation and risk tolerance have all been taken into account, before suggesting a suitable product. Merely taking a signature on benefit illustration does not ensure the product being aligned with the client’s requirements.
The report calls for no upfront, and a level or reducing trail in mutual funds. This can induce churning. In fact, it should be the other way round. It should gradually increase till, say, five years and stay at that level from then on, to disincentivise churning. Also, mutual fund expenses have crept up. There is a proposal to do away with the incentive for beyond top 15 (B-15) cities. Association of Mutual Funds in India has also proposed a phased withdrawal of this, which is good for the consumer and the industry. Fund houses and distributors should increase the pie dramatically and earn more, rather than earn higher commissions per unit of sale.
The report recommends upfront commissions in insurance just on the mortality portion and trail commissions on investments, which it suggests should be level or declining. Though this is a good suggestion, in my opinion, the trail here too should start small and increase over the years and stabilize at a higher level for the rest of the period, to naturally wean away distributors from churning.
The Sumit Bose Committee report has the potential to radically transform the landscape of financial product distribution. It will make the financial services landscape far more responsive to needs of customers, curtail mis-selling, increase transparency and even bring down costs for customers. Overall, this is a very transformative effort. Let us hope it sees the light of the day.

The article written by Mr. Suresh was published on livemint.com on 10th Sep2015

02 September, 2015

Should you pay for financial advice?

You don’t pay for air, water. Neither do you pay for financial advice! So goes the thinking…

Financial advice has always been free... or so you think! The people whom most of you might have been approached were agents or distributors, who had products to sell. They were willing to talk to you and offer “advice”. But, what can you expect? If the only way the agent can earn is through commissions embedded in the products, you should be prepared to be sold products that rewards them wonderfully – and could take them to Paris &; Pattaya, when they achieve their targets!

When Free advice is costlier than paying a fee 

You thought you got free advice – when all you got was a sales spiel & a product that is supposed to take care of your requirement. When you do not know much about finance, all you could do is hope the person you dealt with was honest and gave you the right product. Many times, this trust is misplaced.

That’s why we meet clients saddled with a dozens of endowment plans that mature every year in retirement. The spiel which sold the product was that this is good laddering to take care of requirements in retirement. But what was left unsaid was that this product offers 4-6% returns and there were much better products with which to shore up the retirement years! Such a strategy would cost a person lakhs of rupees in lost corpus accumulation! The agent gets the best commission in this product. The client did not pay a fee – but paid very dearly anyway, indirectly!!! Such cases are very common in our country.

Also Read: Good advice can make all the difference

Poor outcomes

We see the effect of free advice being played out in lots of ways – unsuited products being pushed aggressively, sub-optimal solutions for problems clients have, high cost products offered when there are better suited low cost ones, locking clients into closed ended products, offering NFOs, offering exotic products which are difficult to understand etc. The end result is always the same – the client pays a huge price for not accessing proper advice.

Paying for services - 

We pay for most things we consume . We pay for services rendered – to the maid who works at home, the driver, the dhobi etc. We book tickets for travel, to movies etc., and pay a convenience fee. So, it is not that paying for services is alien to us.

When we step out of our home, we hail a cab and pay for it. We have snacks in the hotel or treat the family at a restaurant and without a word, we pay for this. We are used to paying fees to doctors, lawyers, CAs, architects etc. Back home, we watch cable TV, for which we pay too. In short, we pay for everything we use.

We even pay for things which do not give anything tangible- like taxes - as there is no choice. The government tells us to hold our head high & pay taxes! Tax is a “service charge” for the privilege of being a citizen of the country, hoping & praying for “good governance”, which of course is as elusive as the blue moon sighting!

Paying for financial services – 

Even for financial services, you have been paying, sometimes without your knowledge. The bank debits various charges to your account – for credit card fees, ATM card charges, charges for statements, for bank certificates etc. Banks also extract their pound of flesh when they offer you services by making you invest in products, insurances, FDs etc. Banks use your privileged information ( like bank balances and where your investments are going ) and contact you for cross selling products. Only thing is that you do not realize that you are paying for this.

These payouts you are making indirectly add no value to you. Lot of times they detract you from your goals as the investments done in this way have been done based on sales push & is not borne out of actual requirements.

So, why not engage proper advisors to advice you on finances and ensure you take proper decisions in line with your requirements?

Engaging financial advisors -

Just like going to doctors & lawyers for advice, one needs to identify good financial planners/ advisors for accessing advice that is suitable for one’s specific situation. But finding the right advisor is crucial.

One will need to pay a fee to such advisors, just like one pays to doctors/ lawyers. Firstly, a good advisor will ensure that wrong decisions, which will hamper a person throughout life, are completely avoided.

Secondly, a good advisor would study one’s requirement and suggest low cost options to achieve the goals. The focus is on achieving goals. Engage the services of Fiduciaries.

Thirdly, a good advisor will optimize the investments in line with one’s risk tolerance levels, asset allocation requirements, goals, taxes, tenure & liquidity needs, return expectations etc. and ensure that the returns are optimized. The recommendation would be tailor-made for the client.

All these will ensure that the client will meet their cherished goals by deploying their finances optimally

Paying financial advisors – 

This is a sore point for many. Financial advice has always been free! Most people don’t want to pay for it separately, even when they may be paying much, much more indirectly.

What people need to understand is the total cost of financial services & not just whether they are paying directly / indirectly. The Indirect route is far costlier as agents palm off costlier products for their own pecuniary gains. One needs to get used to paying directly for advice, like we pay other service providers.

For instance, many of us have drivers to save us the hassle of driving to & from work. We pay about Rs.15,000 per month. Over a 25 year period we would be paying over Rs.1 Crore! All this for just taking us from point A to Point B! This service, though important, is not in any way life changing. That is the same for maids whom we employ at home – important / invaluable service, but again not life altering.

The services of financial advisors can be had for much less and is certainly life altering. Their advice has the potential to transform one’s financial life. A good advisor would sort out the chaos, lay down the path to financial freedom and ensure clarity & peace of mind for the family.

That’s priceless – you would agree!

This article was published in moneycontrol.com on 27 Aug-15