Of late demand for guaranteed-return insurance plans has surged as it provides triple benefits-higher fixed returns for a longer-term, tax benefit on both investment amount and maturity proceeds and no reinvestment risk as your investment gets locked-in for a longer term at higher rates even if market rates fall.  As interest rates on longer-term fixed deposits have fallen to below 6% levels, post-tax returns for depositors in the 30% or higher tax bracket will be close to 4%.  So traditional insurance plans that offer guaranteed returns of around 6%, which is tax-free, look attractive to investors.

The tax benefits and life cover are like icing on the cake. Premium payments up to Rs 1.5 lakh per year qualifies for deduction under Section 80C. Not only this, payouts are entirely tax-free under Section 10 (10 d) as these plans come with added insurance cover of at least 10 times the annualised premium.

Even life insurance agents and bancassurance partners are also pushing customers to buy these plans showing the above-mentioned benefits. 

According to a report in the Economic times, industry insiders say that demand for guaranteed insurance plans has surged by 15-20% in the last quarter of FY21. Should you opt for these plans to earn tax-free returns amid falling interest rates on bank fixed deposits and high volatility seen in equity markets?

According to experts, most guaranteed return policies in the market are fetching a higher Internal rate of return (IRR) compared to fixed deposits, which now in some cases even fetch negative real rates. 

“This is a peculiar time, while the short-term interest rates which dictate the bank rates have sharply fallen due to the repo rate cuts by the central bank, longer-term rates have not fallen in similar fashion,” the Economic Times quoted Vivek Jain, investment business head, PolicyBazaar as saying in a report.

As per data available on PolicyBazaar portal, IRRs on guaranteed plans offered by HDFC Life, ICICI Prudential, Bajaj Allianz, Tata AIA, Bharti AXA Life and Max Life all range between 5.4% and 6% for a 30-year old male for a period ranging between 10 and 20 years. In contrast, leading banks such as State Bank of India, HDFC Bank, Kotak Mahindra Bank, ICICI Bank and Bank of Baroda offer between 5% and 5.4% on their fixed deposits having a tenure of five year and more.

“If you look at it, life insurers are getting an average return of 6% on government 10-year bond and 7% of state security bonds where they have to lock in a bulk of their assets. Additionally, for long term AAA papers there is a good premium as well. Insurers are comfortable offering rates between 5% and 6% for customers,” the business daily quoted Rushabh Gandhi, Deputy CEO, IndiaFirst Life as saying.

Although there are visible benefits of guaranteed-return insurance plans, investors also take into account the following facts which an insurance agent will never tell you. These plans have very low liquidity. You can reap the full benefit of these plans only if continue to pay premium for the entire premium payment term of the policy. The policy term is the lock-in period of the plan and there is no cash flow during that period. So before going for these plans ensure that you can spare that amount for the entire term of the policy. 

Typically these plans accrue surrender value from the second year onwards and go up progressively as you pay more premiums. So avoid going for high-value plans that will lock-in a large sum for the long term. You won’t be able to liquidate the policy before it matures.

Secondly, as most of the guaranteed insurance plans are deferred payment plans where you get payout after 10-12 years later. the value of Rs 1 lakh that you will get after 12 years is not going to be the same as it has now. So don't go by the IRR figures quoted by the company and do your own math.

The third drawback is that the insurance cover these plans offer is very low. You will get a life cover of Rs 10 lakh only if you pay Rs 1 lakh as annual premium. So for getting a life cover of Rs 1 crore, you have to pay Rs 10 lakh as annual premium. In comparison in term policies, a 35-year old can get a cover of Rs 1 crore by paying an annual premium of Rs 12,000. So these policies can never be a replacement of term plans.