Highest NAV Guaranteed ULIP : All About NAV Based Guaranteed Plans

NAV based guaranteed plans not attractive enough!

The global economic downturn which sent shivers across financial markets resulted in several investors looking for products that are safe and secure. Making the most of this shift in investor appetite, insurance companies have launched a product which they believed would find takers in risk averse investors. The product called ‘Highest NAV Guarantee Plans’ has been in the limelight for the guarantee it gives investors. Insurance companies assure investors they would receive the highest NAV of the fund during a particular time frame.  For instance, suppose Brinda buys a ULIP in 2009 priced at Rs. 10 NAV having tenure of 10 years with the product promising highest NAV registered by the fund in the first 7 years. On account of volatility in the equity markets, the fund registered the highest NAV of Rs. 25 in year 6, but at the time of maturity, the NAV was Rs. 16. By virtue of the ‘guarantee’ feature of the product, Brinda will get maturity proceeds at the price of Rs. 25 even though the NAV at the time of maturity is much lower.

The target audience for this product is risk averse investors who want to cap their downside risk but at the same time want to earn higher returns than a pure play debt product.

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Concept

Given that a portion of the investment will be in the equity markets, how is it that insurance companies are able to give an assurance of providing the highest NAV within a particular time span? The key lies in the structure of the fund itself. 

The fund is structured in a manner wherein there is no restriction on the quantum (proportion of funds) of investments in debt, money market instruments or equities- i.e. investments can oscillate between 0% and 100% in any of these asset classes depending on the fund managers’ prerogative.

Fund managers would follow the ‘Constant Proportion Portfolio Insurance’ strategy to ensure that the fund will be able to pay off the highest NAV. The strategy involves continuously re-balancing the portfolio of investments between equity and safe assets (debt, money market instruments) such that the returns from the safe assets will ensure a minimum return at all times- in this case returns to maintain the highest NAV attained on the product. The balance funds will be available for investment in equity which is expected to provide the upside to the fund.

Illustration

Suppose the NAV of the product is Rs. 100 at the beginning. The product is a 10 year product guaranteeing highest NAV in the first 7 years. By virtue of the capital protection feature of the fund, initially Rs. 100 is what the firm has to maintain. So the fund manager will put in Rs. 65 @ 6.5% p.a. in a 7 year bond. The balance (Rs. 100-65) i.e. Rs. 35 will be invested in equity. This investment strategy will ensure that, at the end of the 7^th year, Rs. 100 is the maturity value of the bond. So even if the value of the equity investment goes to zero, the fund manager does not have to worry.

After a year assume, the equity portion is now valued at Rs. 45, the new NAV will be Rs. 114 (Rs. 69 debt + Rs 45 equity). Now the fund manager has to guarantee Rs. 114. So he will increase the allocation to debt so as to ensure that Rs. 114 is the guaranteed return.

So eventually fund managers will have more investments in equity the proportion of which will decrease over a period of time making the product more of a debt product.

This product has been successful in garnering investor attention because of way it has been marketed. The terminology used to describe this product has been misconstrued by the investor community. The highest NAV guarantee that these plans talk about is the highest NAV witnessed/registered by that product and not returns by the market and in order to attain the same, the fund will have to invest in debt products whose maturity value is equal to the guaranteed value.

Products currently in the market

• AEGON Religare Wealth Protect Plan
• Bajaj Allianz Max Gain
• Birla Sun Life Platinum Plus-III
• ICICI’s Pinnacle
• LIC Wealth Plus
• Reliance Highest NAV Guarantee Plan.
• SBI Life Smart Ulip
• Tata AIG Apex Invest Assure

Advantages

• Principal Guarantee: In spite of having an exposure to equity markets, this particular product provides a capital guarantee to the investor. This relieves him of tension of worrying about depletion in the principal amount.
• Exposure to equity markets: This product provides investors an upside potential w.r.t returns without having to take the risk of fall in value of principal. One is taking advantage of equity exposure in the beginning.
• Tax Benefit: The premium paid on this product is eligible for tax benefits under Section 80C of the Income tax Act to the tune of Rs. 1 lakh. The maturity proceeds is also exempt from tax under Section 10(10D).

What reduces the attractiveness of the product?

• No transparency in asset allocation: The structure of the product is such that the investment in equity and debt can be anywhere between 0% and 100%.
• Long tenure product: Guarantee on highest NAV is available only on maturity. So in case of any withdrawals in between, or in case of demise, nominees will get the prevailing value of the fund. This makes it a long tenure product.
• Constrains fund manager flexibility: In a falling equity market, the fund manager cannot increase allocation to equity as that would introduce risk to the guarantee. This in effect is opposite to the principle of value investing for long-term returns.
• Cost Element: Insurance companies charge a premium allocation charge, policy administration charge, fund management charge and guarantee charge. For a product that will eventually tend towards being a debt product, the charges depress investor returns and make it less attractive.
• Insurance cover for limited tenure: This product provides insurance cover for a maximum period of 10 years. Most of us would prefer an insurance coverage for longer tenure which in turn makes it more of an investment product.
• Protection of NAV and not of returns: The return on this policy may be high in the beginning if the equity markets do well. But when markets start performing badly, returns will take a hit. Your NAV will be protected but your returns won’t. So on a CAGR basis, your returns will start falling. So if your NAV today is Rs. 10 and the highest NAV in the 3 year period is Rs 25, your CAGR today is 36%. But if the highest NAV for the 7 year period continues to be Rs. 25, then your CAGR falls to 14%.

Is this product attractive enough for investors?

This product is an insurance cum investment product. Insurance benefit is provided for a maximum tenure of 10 years. Ideally investors would want insurance coverage for much longer duration so as to ensure financial security to the family. So this product will not satisfy the insurance need for most of us.  

The investment benefit that this product provides is only if the product is held till maturity making it a long term investment. In case of an untimely death, or early withdrawals, the highest NAV guarantee is not longer applicable. So the core benefit of investment in this product is lost.

It is best not to mix your insurance and investment needs. It thus makes sense to buy a traditional insurance product for insurance coverage and for investment purposes look for a pure play investment product. Investors with a long term horizon can look at Monthly Income Plan (MIP) offered by mutual fund companies which invests primarily in debt (80%) with a small portion in equity. On account of the high exposure to debt, risk element is much lower. Investors can hope for the equity portion to give them the upside in returns. Besides, over longer periods of time, equity markets tend to provide good returns.