What do you think when you see the giant ads on your way home, on newspapers, TV channels – all promising you the highest net asset value (NAV) in a unit-linked insurance plan (ULIP)? Most of us would believe that we would get the highest possible return with zero risk. But as you know, nothing comes for free; hence we put all the products that are guaranteeing NAVs under scanner in order to have an opinion.
A ‘Highest NAV Guarantee’ plan is based on the Constant Proportion Portfolio Insurance (CPPI) model. According to this model, the fund would invest in fixed income securities in order to maintain the previous highest NAV. When the fund value exceeds that NAV, the surplus is placed into stocks. With constant rebalancing of the portfolio, the aim of the fund manager is to not let the unit value fall below that base. Similarly, the proceeds of ‘Highest NAV guarantee’ plans would be dynamically invested in equity, fixed income and money markets instruments and the portfolio asset allocation is dynamically managed and constantly monitored. There is no specific asset allocation that the fund manager has to adhere to. As the policy guarantees the highest NAV, a fund manager may follow conservative approach and allocate more proportion of money into money market and fixed income instrument towards the end of the plan and ensure that investor get the highest NAV without much trouble.
Features:-
- Highest NAV in 7 to 10 years guaranteed with 1 to 2 years of additional policy term cushion within which any shortfall to reach highest NAV guaranteed will be achieved.
- 100% Liquidity after 3 years.
- Premium and any appreciation received under this policy will be eligible for the tax benefits as per the prevailing Income Tax laws.
Let’s Take an Example to understand how this product works
Assuming a person aged 25 pays premium of Rs 10000/- every year into the plan with a tenure of 7 years. In first year, investment will be split between debt and equity in such way that investor get assured NAV of RS 10/- at the end of plan’s tenure i.e. 7 years in our case. So lets assume NAV of Rs 10/- and the Asset Allocation is 20% in Equity and 80% in debt so that even if equities go down, the 80% in debt would make up the rest 20% through interest till the fund’s maturity. Now suppose, the market moves up and NAV goes up to Rs 11 by the end of the first year, at this point, fund manager have to make sure, that he provide at least Rs 11 as the return after next 6 yrs . Now in order to achieve this, all he has to do is keep X amount in debt instruments which will mature in next 6 years and provide Rs 11 at the end of next 6 years. This balancing is done on a continuous basis. Now, with NAV already increased by 10%, he’ll make sure that the debt portion is increased in such a manner that he manages Rs. 11 at the fund’s maturity through Debt instrument’s interest even if equities go wrong.
Costs Involved:-
These types of products guarantee only highest NAV on maturity date but not guaranteeing highest return. You think both are same? But there’s a difference. As we said, that nothing comes for free; these plans are also covered with various types of charges like Premium allocation charge, admin charge, mortality charge, fund management charge and highest NAV guarantee charge. So the units are calculated after deduction of premium allocation charge. So the balance from premium received goes as an investment into the fund. Apart from initial charges, the mortality, policy administration charges and fund management charges are deducted every year from your fund. There is a fund management fee plus a charge for highest NAV guarantee to ascertain you get highest NAV which would be deducted from your fund units. In totality, besides the premium allocation charge, you would end up paying from your fund approximately 2.50% per annum. In the later years, the premium allocation charges may come down but other charges would remain same. That’s the reason why these plans guarantee highest NAV, not highest fund value as charges are accounted by deducting units.
Suitable To:-
These plans are mostly suitable to investors who are ‘risk-averse’ equity investors and can lock in money for 10 years as fund manager follows conservative asset allocation approach and most plans have tenure in range of 8-10 years.
Drawback:-
- Lack of transparency on asset allocation.
- Highest NAV is guaranteed only on maturity, not applicable if you surrender policy
- Long lock-in period of 7 to 10 years.
These products guarantee ‘Highest NAV’ but they may not necessarily provide the highest returns rather they come with higher charges. Investors who are risk-averse and have a 6-8 year horizon are better off with postal schemes or bank deposits which have no charges and provide certain fixed returns. For investors who prefer equity proportion in their investments, Monthly Income Plans of mutual funds are a good option. MIPs have an allocation of 10-15% in equity with the remaining 80-85% in fixed income securities. Also, the no entry load regime brings down the cost of your mutual fund investments to much lower than these plans. 10 years is an enough time for plain-vanilla equity investments. So, even if you invest your funds into any Index fund following Nifty or Sensex, you need not worry about market downsides, as the probability of loss in equities is almost nil after 5 years of investment.
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