The following is an actual interaction with one of my clients. I am sure several readers will identify with his situation and benefit from the solution offered.
This was the email that he wrote to me:
“Succumbing to the aggressive sales pitch of the agent and the fact that there were precisely three days to go for the end of the fiscal year, I hastily bought an endowment policy four years ago. This 15-year policy offering a sum assured of Rs 8 lakh requires me to pay an annual premium of Rs 52,190.
However, now I find that I am stuck between a rock and a hard place. The return is too low and the commitment too high. The problem is that four years have already passed. I want to come out of this commitment but my agent says that if I stop, I will lose most of my money already invested. I have already paid the premiums for four years, amounting to Rs 2,08,760 (Rs 52,190 x 4). Discontinuing the policy now would mean a loss of the premiums paid. At the same time, continuing it would mean throwing good money into a bad deal. So what is to be done? Is there a way out?”
Here’s the solution I offered him:
“Sometimes, you make the right decision and sometimes you have to make the decision right. This is one situation where you have to have the conviction of making the decision right.
The first step is to realise your mistake. The second is to not repeat it. From now on, please avoid combining insurance and investments. At best, if you need insurance, buy a term plan.
Now, as for your current problem, there is no way of coming out without pain. However, you have the choice of limiting the amount of pain or letting it continue. It’s not as if you will lose all your money. Though you may not recover all of it, every policy has a surrender value and you should surrender the policy with immediate effect. Yes, you will lose money.
However, if you continue, you will lose much more. I can go to the extent of saying that even if the surrender value is zero (that is, if you don’t get anything back) — even then, surrendering and getting out of future commitment may actually be profitable. If you henceforth invest your money wisely, you will find that you can more than make up for your loss.
Now let’s examine the case in terms of the figures involved. First of all, though the sum assured of the policy is Rs 8 lakh, taking into account the expected bonus (which is paid on a non-compounded basis), you would in all probability receive Rs 12.50 lakh after 15 years. Even with the bonus included, the return works out to 5.65% p.a., a rate that may not even cover inflation over the term. So, fundamentally, it would be a good idea to discontinue this investment.
Secondly, as an investor in this policy, you need to know its surrender value. Most insurance policies come with specific surrender values (the value that the investor will get if he were to discontinue the policy for any reason). More often than not, agents forget to apprise investors of the same — what the investor doesn’t know will not hurt him and secondly if the premiums stop, so does the commission.
After studying your policy papers, we found that you will have to forego the first year’s premium and will get 50% of the balance premiums paid as the surrender value of the policy. In other words, in place of Rs 2,08,760 that has already been paid, the surrender value that you will receive will be only Rs 77,673.
Now, prima facie, most investors will reject this idea completely. Losing Rs 1,31,087 (Rs 2,08,760 less Rs 77,673) works out to a loss almost 63%. It would seem like it is better to continue the policy for whatever it is worth, rather than discontinuing it and losing 63% of your investment.
However, the numbers suggested otherwise. You have purchased the policy on March 28, 2004. As on March 28, 2007 (you would have paid the premiums for 2004, 2005, 2006 and 2007), you would receive Rs. 77,673. Now let’s say you keep investing Rs 52,190 each year for the remaining 11 years on your own, instead of paying the premium on the policy. The goal is that you should reach a value of Rs 12.50 lakh, which is what you would have otherwise got, had you continued the policy.
Actually, we also need to make another adjustment — the policy would have given you an insurance cover of Rs 8 lakh. To keep the same constant, buy a term policy. At your age (33 years), the annual premium would work out to Rs 2,677. So now, you will invest the balance Rs 49,513 (Rs 52,190 less Rs 2,677) over a period of the remaining 11 years.
To rephrase the object of the exercise, we are interested in knowing what rate of interest should you earn such that you are indifferent to continuing the policy or surrendering it and reinvesting the proceeds on your own. If you earn anything more, you would be better off and with anything less, you should continue with the original policy.
The rate worked out to 9.96% per annum. In other words, even after surrendering and foregoing almost 63% of the premium paid, a rate of 9.96% p.a. brings you on par with the return on the policy. As mentioned before, if you earn more, you would be better off.
For example, were you to earn say 12% p.a. (which is anyway a conservative estimate) instead of 9.96%, the investment would grow to Rs 13 lakh, and you would actually benefit. By the way, if we impute the rate of return of say Reliance Growth Fund, your investment would have grown to around Rs 52 lakh.”
To conclude
The point of this exercise is not to showcase how much my client would have benefited by assuming various rates of return. Instead, it is to point out that when it comes to investments, it is always better to take remedial actions now than later. Of course, it goes without saying that prevention is better than cure. Or like Donald Trump says, “Some of your best investments could well be the ones that you don’t make.”
This was the email that he wrote to me:
“Succumbing to the aggressive sales pitch of the agent and the fact that there were precisely three days to go for the end of the fiscal year, I hastily bought an endowment policy four years ago. This 15-year policy offering a sum assured of Rs 8 lakh requires me to pay an annual premium of Rs 52,190.
However, now I find that I am stuck between a rock and a hard place. The return is too low and the commitment too high. The problem is that four years have already passed. I want to come out of this commitment but my agent says that if I stop, I will lose most of my money already invested. I have already paid the premiums for four years, amounting to Rs 2,08,760 (Rs 52,190 x 4). Discontinuing the policy now would mean a loss of the premiums paid. At the same time, continuing it would mean throwing good money into a bad deal. So what is to be done? Is there a way out?”
Here’s the solution I offered him:
“Sometimes, you make the right decision and sometimes you have to make the decision right. This is one situation where you have to have the conviction of making the decision right.
The first step is to realise your mistake. The second is to not repeat it. From now on, please avoid combining insurance and investments. At best, if you need insurance, buy a term plan.
Now, as for your current problem, there is no way of coming out without pain. However, you have the choice of limiting the amount of pain or letting it continue. It’s not as if you will lose all your money. Though you may not recover all of it, every policy has a surrender value and you should surrender the policy with immediate effect. Yes, you will lose money.
However, if you continue, you will lose much more. I can go to the extent of saying that even if the surrender value is zero (that is, if you don’t get anything back) — even then, surrendering and getting out of future commitment may actually be profitable. If you henceforth invest your money wisely, you will find that you can more than make up for your loss.
Now let’s examine the case in terms of the figures involved. First of all, though the sum assured of the policy is Rs 8 lakh, taking into account the expected bonus (which is paid on a non-compounded basis), you would in all probability receive Rs 12.50 lakh after 15 years. Even with the bonus included, the return works out to 5.65% p.a., a rate that may not even cover inflation over the term. So, fundamentally, it would be a good idea to discontinue this investment.
Secondly, as an investor in this policy, you need to know its surrender value. Most insurance policies come with specific surrender values (the value that the investor will get if he were to discontinue the policy for any reason). More often than not, agents forget to apprise investors of the same — what the investor doesn’t know will not hurt him and secondly if the premiums stop, so does the commission.
After studying your policy papers, we found that you will have to forego the first year’s premium and will get 50% of the balance premiums paid as the surrender value of the policy. In other words, in place of Rs 2,08,760 that has already been paid, the surrender value that you will receive will be only Rs 77,673.
Now, prima facie, most investors will reject this idea completely. Losing Rs 1,31,087 (Rs 2,08,760 less Rs 77,673) works out to a loss almost 63%. It would seem like it is better to continue the policy for whatever it is worth, rather than discontinuing it and losing 63% of your investment.
However, the numbers suggested otherwise. You have purchased the policy on March 28, 2004. As on March 28, 2007 (you would have paid the premiums for 2004, 2005, 2006 and 2007), you would receive Rs. 77,673. Now let’s say you keep investing Rs 52,190 each year for the remaining 11 years on your own, instead of paying the premium on the policy. The goal is that you should reach a value of Rs 12.50 lakh, which is what you would have otherwise got, had you continued the policy.
Actually, we also need to make another adjustment — the policy would have given you an insurance cover of Rs 8 lakh. To keep the same constant, buy a term policy. At your age (33 years), the annual premium would work out to Rs 2,677. So now, you will invest the balance Rs 49,513 (Rs 52,190 less Rs 2,677) over a period of the remaining 11 years.
To rephrase the object of the exercise, we are interested in knowing what rate of interest should you earn such that you are indifferent to continuing the policy or surrendering it and reinvesting the proceeds on your own. If you earn anything more, you would be better off and with anything less, you should continue with the original policy.
The rate worked out to 9.96% per annum. In other words, even after surrendering and foregoing almost 63% of the premium paid, a rate of 9.96% p.a. brings you on par with the return on the policy. As mentioned before, if you earn more, you would be better off.
For example, were you to earn say 12% p.a. (which is anyway a conservative estimate) instead of 9.96%, the investment would grow to Rs 13 lakh, and you would actually benefit. By the way, if we impute the rate of return of say Reliance Growth Fund, your investment would have grown to around Rs 52 lakh.”
To conclude
The point of this exercise is not to showcase how much my client would have benefited by assuming various rates of return. Instead, it is to point out that when it comes to investments, it is always better to take remedial actions now than later. Of course, it goes without saying that prevention is better than cure. Or like Donald Trump says, “Some of your best investments could well be the ones that you don’t make.”
No comments:
Post a Comment