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News & Views

Monday, Dec 27, 2010

The trap called guaranteed NAV

[Source : The Economic Times]

ET Wealth approached a bank relationship manager to understand guaranteed-NAV Ulips. The explanation was built on falsehoods that, alarmingly, seemed true and logical.

It is guaranteed,” said the relationship manager (RM), stretching the ‘ees’ for emphasis. He needn’t have. I got the idea, or at least, pretended to. The guaranteed- NAV Ulip (unitlinked insurance plan) would ensure that I earn the highest returns the market delivered during the tenure of the policy. A false smile in place, I sat back on the plush couch of the private sector bank.

Ostensibly, I was digesting the implication, guaranteed returns from an equities instrument for 10 years. The absurdity of the promise was clear. How are investors misled so easily? Don’t they crunch numbers or ask how the insurance company will assure high returns consistently? Oblivious to my thoughts, the RM had ordered two cups of coffee and the application form of the Ulip. May be it was my imagination, but his smile seemed smug.

What was he thinking? “One step closer to my monthly target? Just a few deals away from the grand prize of a trip to the Caribbean?” “You have to sign on every page of the form. I will fill up the other details. You are investing Rs 1 lakh a year, right?” asked the RM, breaking my reverie. True to my part of a gullible 34-year-old investor, I merely glanced through the form.

Busy, impatient investors did not read through the fine print. It was supposed to be a waste of time. The problem was I had no intention of investing a single rupee in the instrument. The charade had got the better of me. So there I was, stalling for time, groping for an ingenuous excuse to get out.

“Can you please explain once more how is the NAV guaranteed?” I asked. It was lame, but nothing else came to mind. The RM did not bat an eyelid. May be he was accustomed to investors asking for repeats of his story about guaranteed-NAV Ulips. Say a lie a thousand times to make it true.

“Of course. This plan is a 10-year unitlinked insurance plan which guarantees the highest NAV during the first seven years of the policy. You invest at the rate of Rs 10 per unit. Say, after five years, the NAV of one unit is Rs 35—the highest it reaches in the policy’s term. But by the time of maturity, the NAV has fallen to Rs 28. Nevertheless, your returns will be calculated at the rate of Rs 35 per unit. It is a win-win situation,” said the RM.

It certainly seemed so, the way he put it. The RM’s final push was subtle: “So the insurance company offers the best of three options: the highest NAV of the first seven years, the NAV at maturity or Rs 10 per unit." What he did not say: “The policy goes all out to ensure the best for you. You can’t get a better deal.” How generous of the insurance companies. One would think they are a non-profit organisation, doling out the best returns for every investor.

“Ulips invest in the stock market which goes up and down everyday. So how can they guarantee returns by investing in something so volatile?” I asked, wanting to gauge whether the RM knew how the ‘guaranteed returns’ were fixed. “This is why you should invest in it. It is what makes this Ulip special,” he replied. I probed further: “Let’s say the guaranteed-NAV policy raises Rs 1,000 crore across India. The money is invested in the stock market.

As per your example, five years later, the NAV touches Rs 35. This means the Rs 1,000 crore has grown to Rs 3,500 crore. But at the end of 10 years, when the NAV is Rs 28, the corpus is only Rs 2,800 crore. How can the company pay Rs 700 crore extra when it doesn't have the money?”

For a better perspective, I added: “And what if there is a crash in the markets and the NAV drops to Rs 15 at maturity? Then the insurer will have a corpus of Rs 1,500 crore but need to cough up Rs 3,500 crore.” The RM stared at me. The unassuming investor had metamorphosed into an aggressive, number-talking demon. One thing was certain, he did not know how the highest NAV of the Ulips are fixed. It wasn’t a surprise.

Insurers are cagey about the math behind the guarantee. The trick is to gradually switch investments from equities to debt. The Ulips start out with maximum exposure to equities. As the date of maturity nears, the proportion of debt investments goes up. This is done by regularly booking profits from equities and transferring them to safe havens, ensuring that the NAV does not breach a predetermined level. Any loss due to the guaranteed returns is minimal.

You get the highest NAV of the policy, but it is not the same as the highest level of the market. For some moments, I toyed with the idea of explaining the concept to the RM. Then I realised it would do no good. A fresher from a B-school, he had been taught to sell, not to understand how a product is constructed.

His next remark confirmed my opinion: “I don't know the answer to your question. But if you leave your number, I will check and revert. Meanwhile, take the product brochure and the application form.” The bank had trained him well. The mask of the perfect salesman was back. Not needing an excuse any more, I got up and left the bank.


No instrument that invests In equities can guarantee returns.

The Securities and Exchange Board of India does not allow even mutual funds to guarantee returns.

The highest NAV is not the same as the highest level of market during the policy's tenure.

There is no minimum return guaranteed by the policies.

The insurance companies do not explain how they manage to deliver the guaranteed returns without incurring losses.

There are more transparent equity instruments, such as mutual funds, which offer exposure to stocks.

UTI Mutual Fund: When guaranteed returns went bust

A few years ago, the Unit Trust of India (UTI) had around Rs 17,000 crore invested in its assured return schemes. All these schemes had to be shut down in 2002 when things started to go haywire. So, be on your guard when you hear guaranteed and equities together.

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