In response to my article on LICs new Jeevan Suraksha Policy instituted under the new Sec. 80CCC (income rebate on contributions up to a ceiling of Rs 10,000 every year), I got the following reaction from Mr. H. H. Faruqi, spokes-person for LIC. I have heavily scaled it down due to constraint
Some modifications have been effected in the plan from 1.10.96, which you appear to be unaware of : a) If the policyholder has not indicated the option before the pension becomes due, LIC will choose the pension that guarantees payment for 15 years certain and for lifetime thereafter b) This is the best feature. If the policyholder dies during the deferment period, pension between 50 and 85 per cent of the pension which he would have been eligible for, had he contributed till the selected retirement age, is payable to the spouse, for 15 years certain and life thereafter. The actual amount depends upon the period elapsed. c) minimum entry age is now 25 years.
We have the following comments :
1. Though as mentioned in your article, choices of various annuities are available to the policy holders on the vesting date, the `15 years certain and life thereafter' option has a great advantage over all the other options, though the pension is a little less. If the pensioner dies after he starts receiving the pension, the full pension becomes payable to spouse/nominee for the balance term of 15 years. But, if the annuitant survives the 15 years, the pension is payable till the annuitant survives. Thus, he is protection both ways. Moreover, the spouse is secured to get a pension.
For clarity, let us take a person aged 30 with a policy term of 30 years and monthly premium of Rs 250.
1. If he survives the premium paying period, he will have a capital base of Rs 4,28,816 on which, a monthly pension of Rs 4,228 will be paid from the age of 60. If he dies before 15 years, the pension is paid for the balance period. If he survives this period, he gets the pension for lifetime.
2. But, say, if death occurs after payment of the first premium of Rs 250 itself, his spouse is entitled to a monthly pension of Rs 2,114 starting immediately, for 15 years certain and life thereafter. Clearly, life cover has been given for the deferment period.
This also includes a return of capital (ROC) because our calculations are based on a lower rate of return (@10.44 per cent p.a.). We feel this plan carries a long-term guarantee with attractive benefits. The capital is returned in a manner similar to the `Equated Monthly Instalment' technique of loan repayment. Low capital content at the start and more later.
We have to also account for the expenditure and mortality in the premium rates.
Your calculations are right for post maturity pension payment @1.09 per cent p.m. or @13.89 per cent p.a., but it is based on a different option. In the case of 15-years certain and with the spouse as beneficiary in the event of policyholder early death, the rate is slightly lower, at 9.04 per cent p.a. The corpus is returned if the pension is paid over an expectancy period of 18.62 years for a person aged 60 years. In any case, the pension payment is guaranteed for 15 years.
A portion of the pension fund is likely to be invested in debt and equity. In the likely event of LIC earning high returns on the fund, these will be passed on to the pensioners at the time of vesting. This will be in addition to the guaranteed amount depending upon the actuarial surplus. This plan offers a very long-term guarantee and a share in surplus which is very beneficial.
There are two hidden benefits. First, the immediate annuity rates prevalent on the vesting date, if favourably comparable to the rates under Jeevan Suraksha, will be used to rework the pension amount. As per the prevalent immediate annuity rates for 15 years guaranteed pension, the monthly pension of Rs 4,228 will then be Rs 4,685, higher by 10.81 per cent.
The second hidden benefit is the terminal bonus, which will depend upon the valuation surplus and result in increase in corpus. The present rate under Jeevan Dhara is Rs 3 per Rs 1,000 cash option for each deferment year. Even at this rate, the corpus will be accumulated to Rs 4,67,409 in the above example. This will bring about a further increase in the monthly pension.
Your suggestion about exercising commutation option is correct in the current situation. But if the market rate of interest falls considerably, it may not be worthwhile to commute pension. We request you to reexamine your valuable opinion.
My not-so-valuable revised opinion
When I first wrote the article, I was not aware of the changes in the provisions incorporated on October 1, 1996. The most significant change is that when the policyholder fails to intimate his choice of the plan, LIC automatically gives him the `Life-only' option which carries a higher rate. Now it will give `15-years certain and life thereafter' which has a lower rate. I submit nothing is higher or lower. Both options are equivalent from the actuarial point of view.
I do realise that Jeevan Suraksha is a contract between LIC and the policyholder and if the interest rates fall in the future, LIC will be facing the same problems as are faced by some of the MFs who gave avaricious promises of minimum returns and are now finding themselves in a tight corner.
Investment in the capital market related debt and equity is quite rewarding and the current rate of returns is 16 per cent+ p.a. If I am permitted to assume a rate of only 1 per cent per month (12.68 per cent p.a.), I find : 1. Pre-vesting: Rs. 250 p.m. paid for 360 months invested @1 per cent p.m., grows to Rs 8,73,741. The same sum in JS grows to Rs 4,28,816. The difference is Rs 4,50,941, less the hidden benefits.
2. Post-vesting: A car costing Rs 4,28,816 given on HP for 18.62 years with an instalment of Rs 4,228 p.m., will recover the capital if the rate is 0.8307 per cent p.m. or 10.44 per cent p.a.. If the interest rate is 1 per cent p.m., the instalment is higher at Rs 4,288 and the capital remains intact, not only after 18.62 years but also for all time.
The difference is Rs 60 p.m. received for 18.62 years plus Rs 4,28,816 receivable at the end of the term of 18.62 years, less the hidden benefits.
Comments: This is the current cost of insurance. It is important to adopt some protection against any unforeseen fall in interest rates. I personally feel that LIC has adopted the policy of being ultra conservative. Some knowledgeable persons may move to more risky avenues. Or, they may wait for the insurance gates to be thrown open. LIC has been commendably protecting the interests of millions. I do not wish anyone moves away from this excellent institution, even post-privatisation.
All said and done, there is one possibility. Persons in the highest tax bracket may find that they are getting all the benefits above if their contribution was actually Rs 250, when their out-of-pocket contribution to the scheme is effectively Rs 150: JS may work out to be favourable for the very rich.
Nonetheless, they will do well to have a look at the avenue of Deep Discount Bonds from PSUs or the growth and liquid schemes of mutual funds. The concessional tax rate on capital gains here which the investor can pocket in future, may outweigh the immediate tax concession offered by JS.
It is not too late for LIC to review its overcautious approach and amend JS once again. Before closing, I once again repeat, I do not want anyone to move away from LIC to riskier avenues.
Persons in the highest tax bracket may find that they are getting all the benefits if their contribution was actually Rs 250, when their out-of-pocket contribution to the scheme is effectively Rs 150