In Life - No Need To Defend Rate Of Return

Vishakha RM, MD and CEO, India First Life Insurance Co, a passionate spokesperson for her industry, was eloquent and combative when asked about the perception that insurance companies offered lesser returns compared to other products in the market. She contested it point by point and argued that a guaranteed return provided by insurance companies through their traditional products, even if it was lower, was not something to be scorned at, given the commitment for the long term as well as the cost of protection. 

This CEO was clearly not on the defensive even as she strove to clear the air on the many misconceptions that float around insurance products. Excerpts:

Are mutual funds scoring over insurance companies in offering what customers want? Or is it that insurance companies are not getting their due?

I think the basic structure of both mutual funds and insurance companies, even on a ULIP platform, is different. In insurance companies, you rarely see the chief investment officer (CIO) being marketed, like a star fund manager would be marketed by an MF.

That is because the structure at the back-end, on how the funds need to be managed, are regulated to a large extent by IRDA. There are sector limits, company limits, caps on investments in rated paper, besides capital and solvency margins.

Unlike an MF, which can embark on assets under management that are multiples of its capital, in insurance companies, as your AUM goes up, your requirement of capital also goes up. You need to look at all these when you are comparing.

You need to look at risk and return. These structural safeguards put in place by the regulator need to be given a price. That is also a return, in my view. That is how I look at the difference between these two.

There is a perception that life insurance companies don’t offer great returns as an investment product. Your views?

Life insurance companies offer a structure to your fund management. That is also true for a traditional product. They are often beaten to death saying that they don’t offer great returns. I think the way they are perceived is wrong. We need to stand up and speak out. Are you saying a 5 per cent return guaranteed over 15 years is too low?

Isn’t it, relative to inflation and interest rates now…

Interest rates are falling. Remember, when interest rates are falling, inflation is also falling. So, don’t expect inflation to continue at this rate all the time. Inflation should reach 2 per cent in the next 15 years if we become a more mature economy, going by global experience. Then is a 5 per cent return good or bad?

Yes. But compared to, say, the returns that MFs offer over that period, which is around 15 per cent, you have to say that 5 per cent is less.

You are forgetting the protection and the guarantee. You are taking protection for granted. The risk of guarantee is on the life insurance company. It is the shareholder who takes that risk. We provide for it through capital adequacy. Traditional products are, from an insurance company’s perspective, a lot of liability.

The kind of reserves that get created, the kind of ALM (asset-liability management) to meet that long-term guarantee is like the duck waddling — there is a lot of furious movement underneath the surface.

Who is giving that guarantee? So, when you compare it with MFs, you have to realise MFs don’t have guarantees. And we have seen cases where after some years (nearly seven or eight years), you get back nothing from mutual funds. That is a real risk.

Are they bad?

I am not saying they are bad. They serve a purpose. All I am saying is that traditional funds of insurance companies are not bad either and they too meet a need.

There are people who put money in fixed deposits although they know it suffers tax and that there is a money market MF option, where they may be better off. Still, you can’t move them from FDs.

They are people who understand the cost of guarantee. In their mind, the cost of guarantee outweighs every other return.

What stops insurance companies from tapping that market, if there is potential?

I think it is because of a basic inability to project into the future. If you only look at the guarantees that a life insurance company offers in the immediate term versus what a bank offers in the immediate term, then we will be lower. But banks offer it for a shorter duration.

But bank do offer fixed rates for three years, sometimes five years.

We are offering guarantees for 15 years and 20 years. Well, they offer, say, 8 per cent for five years. But what in the sixth year? Or seventh?

But, they offer liquidity. You can get out any time. Whereas you can get out of an investment in life insurance policy only with sizeable costs — forfeiting quite a lot as surrender charges.

I agree. That is exactly the point. Look at what your needs are. Yes, even if insurance plans are illiquid, why do you want liquidity for a plan for your child? Why would you want to take out your money if you are saving for a child’s education? I think you should not be able to take it out.

That would be kind of forced discipline?

Yes. Financial discipline is completely underrated. This is a problem across income classes — both blue collar and white collar. Life insurance companies,whether you like it or not, by their structure, force financial discipline on you. You can’t take it out, you have to pay, you will get the benefit at the end of the term.

That is something people don’t realise fully — the difference between short-term guarantees and long-term guarantees. The second is about appreciating the cost of guarantee itself and what the trade-off is. The third is the imposition of financial discipline and mistaking the financial discipline for illiquidity. And the fourth point is that most products have something called maturity bonus.

So, how does the maturity bonus work?

If you look at traditional plans, there is a maturity bonus — which means I am guaranteeing you a certain base return. The way it is structured is that 90 per cent of what you earn goes back to the customers. You can only keep 10 per cent of what you earn as a life insurance company.

How you earn that is by investing in the market. This you do with a conservative approach — because you have to preserve capital and give guaranteed returns. You may do a bit more in equity in the earlier years and a little less in equity and more in debt in the later years, because you have a responsibility to pay back capital and guarantee as insurance company.

If you actually earn more than what you promised to pay, that goes back as maturity bonus — even if we are not guaranteeing that now.

We don’t need to be defensive about our traditional plans. Even if we are giving a return of 5 per cent, I am passing on everything that I can. And we have done a good job considering stability, long-term returns and commitment for the long term. Don’t compare this 5 per cent with an 8 per cent return without taking into account all these other things.