Pension plans: What to look for

The Indian pension fund sector is growing rapidly with most private insurers having entered the fray with a range of products.

Discussions with customers and advisors reveal that there were several key points that potential customers must keep in mind while going in for that pension policy.

The list below is not exhaustive. Nor is it meant to be. What has been attempted is to focus on issues that potential customers need to clarify as they could have a significant impact on the returns they are expecting from the policy.

Bonus calculation

In every insurance product the basis of bonus calculation is very important. Different insurance companies have their own ways of calculating returns -- some declare it as a percentage of the premium, while some as percentage of the sum assured.

In the above illustration both 'A' and 'B' have declared the same bonus of 5 per cent.

In case of insurance company 'B' the quantum of return is better as the bonus has been declared as a percentage of the sum assured.

In the case of 'A' however the bonus has been declared as a percentage of the premium and is therefore much lower.

Life cover

The premiums an individual pays are invested by the insurance company. The amount 'invested' to earn a return would differ if there were some additional benefits added on to the pension policy such as disability rider, life cover, et cetera.

How this would affect your return is shown below.

From the above illustration it is clear that everything comes at a cost.

In the above table the two insurance companies have declared same return but the insurance company 'B' has stood better in terms of returns.

If the individual has enough insurance cover then it would always be advisable to look out for a regular pension plan.

Sum assured of the policy

Another important aspect potential customers need to evaluate is the quantum of sum assured they are getting, for a given premium, as compared to other comparable policies.

The importance of this is underscored in the table below:

In the above illustration it is assumed that both the insurance companies declare sum assured based returns.

'A' still stands out to be a better choice as it gives a better absolute return. Also, given that percentage returns are comparable, the lump sum on maturity would also be more in the case of 'A'.

Terminal bonus

It is general practice for some agents to include terminal bonus in the lump sum that is payable on maturity.

Terminal bonus is bonus declared on maturity of the policy and entirely depends on the performance of the insurance firm over the tenure.

Inclusion of terminal bonus would inflate your lump sum and thus increase your pension.

Therefore, always ask your agent about what all is included in the lump sum of your pension illustration.

In the above illustration it is apparent that if the terminal bonus were not to be included in the lump sum, the pension at the end of the tenure of the policy would be much lower than otherwise.

It is, therefore, advisable that you check your advisor from including large terminal bonuses for the purpose of calculating the pension on maturity.

In other words, even if terminal bonus must be included it must be on the conservative side, something like 25 per cent of premiums paid or sum assured as the case maybe.

Compounding returns

Another marketing tactic that is winning over customers is the promise to pay returns that are compounded (we all know the benefits of compounding).

Most insurance policies pay a simple return i.e. interest on interest is not paid. Therefore it is only fair to be drawn to pension policies offering compounded returns. However, potential customers must note the fine print in some such policies on offer -- like for instance, one company declaring compounded returns on its pension policy does not declare bonuses for the first five years!

Without getting into the numbers here, suffice it to say that by not declaring bonuses for the first five years, the benefit of compounding has been diluted in the first place!

So the next time you call an agent to discuss a pension plan, make sure to ask these five questions:

How is the bonus calculated?

• Is there any life cover attached to the pension plan?
• What would the sum assured I would get, given the premium, if I were to go in for other comparable pension policies?
• What is the quantum of terminal bonus that has been built into the calculations to arrive at the projected lump sum on maturity?
• Are returns simple or compounded? When will the insurance company start to attach bonuses to my policy?