Yes, your age at the time of purchase affects the return that you earn in investment and insurance combo products such as traditional (endowment) life insurance plans and ULIPs.
Everything else being same, lower your age at the time of purchase, better will be your returns.
Why should age affect returns in traditional plans and ULIPs?
That is a good point. Your age does not affect your returns in mutual funds, stocks, bonds, EPF, NPS, or PPF. Everyone, irrespective of age, earns the same return.
Yes, there is a minor exception in bank fixed deposits, where senior citizens are offered slightly superior interest rates but that is it.
In pure investment products, returns do not depend on your age.
However, that’s not true for traditional life insurance plans (endowment plans) and ULIPs.
Why?
Because traditional life insurance plans and ULIPs do not offer investment benefits alone. These are life insurance products and hence must offer life insurance coverage too. Now, the life insurance coverage does not come free. And the older you are, the more expensive life insurance gets. Higher cost means lower return.
But you do not have to pay anything extra from your pocket for life cover. How is life cover charged and adjusted in these plans?
This part is interesting. And the way this life insurance cost is recovered and how it affects your net returns is different in ULIPs and traditional plans.
Let us understand this with the help of examples.
How your age affects returns in traditional plans?
Let us consider a traditional life insurance plan to see the effect.
LIC New Jeevan Anand is a non-linked participating life insurance plan.
Maturity benefit in LIC New Jeevan Anand = Sum Assured + Vested Simple Reversionary Bonuses + Final Additional Bonus
Sum Assured is the minimum death benefit.
Simple reversionary bonus is linked to Sum Assured and is announced at the end of each year. Remember the bonus is paid at the time of policy maturity only.
In addition, the policyholder will get Final Additional Bonus (FAB) at the time of maturity. Only FAB announced in the year of maturity will be applicable to your policy. FAB is also linked to Sum Assured.
You can see both the bonuses are linked to Sum Assured.
Therefore, if Amit (30) and Rahul (50) purchase LIC New Jeevan Anand for a Sum Assured of Rs 10 lacs on the same day with the same policy tenure, both will end up with the same maturity corpus.
If both end with the same maturity amount, shouldn’t their returns be the same?
No, because Amit and Rahul will pay different annual premiums. Rahul will pay a higher premium because of his age, and this will affect his returns.
Let us assume both purchase the plan for 20 years with Sum Assured of Rs 10 lacs.
The premium for Amit (30) will be Rs 58,362 in the first year and Rs 57,105 for the subsequent years.
The premium for Rahul (50) will be Rs 72,085 in the first year and Rs 70,533 for the subsequent years.
Let us further assume LIC announces a reversionary bonus of Rs 45 (per Rs 1,000 of Sum Assured) for the next 20 years. Additionally, it announces a FAB of Rs 500 (per Rs 1,000 of Sum Assured) in the year of maturity.
Reversionary Bonus per year will be Rs 10 lac/1,000 X 45 = Rs 45,000
FAB in the year of maturity will be Rs 10 lacs/1,000 X 500 = Rs 5 lacs
Maturity corpus = Rs 10 lacs (Sum Assured) +
                                     Rs 9 lacs (Rs 45,000 X 20) +
                                    Rs 5 lacs (FAB) = Rs 24 lacs
Both end up with Rs 24 lacs at maturity.
Amit earns a return of 6.62% p.a.
On the other hand, since Rahul pays a much higher premium for the same maturity value, he ends up with 4.81% p.a.
As you can see, the age at the time of purchase of policy affects the return.
Does this happen with ULIPs too?
Yes, your age will affect returns in ULIPs too (everything else being the same).
However, ULIPs work in a slightly different fashion as compared to a traditional plan.
In the case of traditional plans, your annual premium itself is a function of age and Sum Assured. The function is a black-box, and I do not how it works.
In the case of ULIPs, you choose the premium that you can pay. Sum Assured is a multiple of the annual premium. Let us say 10 times.
So, if you agree to pay an annual premium of Rs 1 lac, the Sum Assured will be Rs 10 lacs. You can see age is nowhere part of the equation in this case.
However, in the case of ULIPs, your units are periodically sold off to recover mortality charges. Mortality charge is the cost of providing life cover to you. These mortality charges go towards providing you the life cover.
Mortality charges increase with age (just like how term life insurance premium increases with age).
I reproduce a table of mortality charges from a popular ULIP. These charges are per Rs 1,000 of Sum Assured.
In a ULIP, every month, the insurance company calculates the Sum-at-risk.
Sum-at-risk is the amount of money the insurer needs to pay from its own pocket in the event of the demise of the policy holder.
For Type-1 ULIP, Sum-at-risk = Sum Assured – Fund Value
For Type-2 ULIP, Sum-at-risk = Sum Assured
Mortality cost in a month = (Sum-at-risk * Mortality Charge as per table ÷ 1,000) ÷ 12
Let us understand with the help of an example.
Amit purchases a ULIP at the age of 30 and Rahul aged 50 purchases the same ULIP (and chooses the same fund) on the same date. The annual premium and Sum Assured are also the same.
After 5 years, Amit is 35 and Rahul is 55.
For the sake of simplicity, let us assume we have a Type-2 ULIP where the Sum-at-risk is always equal to Sum Assured.
Mortality charge for age 35 = Rs 1.2820 per Rs 1,000 of Sum Assured
Mortality charge for age 55 = Rs 7.8880 per Rs 1,000 of Sum Assured
Mortality cost for Amit in that month = (10 lacs X 1.2820/1,000)/12 = Rs 1,282/12 = Rs 106.8 + 18% GST = Rs 126.03
Mortality cost for Rahul in that month = (10 lacs X 7.8880/1,000)/12 = Rs 7,888/12 = Rs 657.3 + 18% GST = Rs 775.65
Now, these charges must be recovered through cancellation (sale) of ULIP fund units. Since Rahul must pay more, more units will be cancelled from his account.
Note: Mortality charge is linked to the current age of the investor. And not the entry age. I have done this calculation for specific ages (35 and 55). As Amit and Rahul age, the mortality risk charge as per their prevailing age will be applicable. Hence, will increase.
Everything else being the same, Rahul will sell more units than Amit to pay for mortality charges. Hence, at the time of maturity, Amit will have a greater number of units. NAV is the same.
Therefore, Amit will end up with much larger corpus than Rahul at the time of maturity (say after 15 years).
Lesser mortality charges à Lower number of units sold à Greater number of units at maturity à Higher corpus
With ULIP, Fund NAV may not be indicative of your returns
This brings me to a slightly unrelated but an important discussion.
Many times, during sales presentation of ULIPs, salesperson points to the growth in NAV to show how your corpus would have grown with a particular ULIP. That past returns do not guarantee future returns is another matter altogether.
However, even if the past were to repeat itself, you would not earn the same return as shown in the illustration.
Why?
This is because some of your units will have to be redeemed to recover various charges including mortality charges.
Just to give an example, suppose you get 1000 units of Rs 100 each when you invest in the plan. At the end of 5 years, the NAV has grown from Rs 100 to Rs 200. That is a return of 14% p.a.
However, if the number of units goes down to say 900 (100 units used to square off various charges), your return is only 12.4% p.a. (Rs 1 lac has grown to 900X200= 1.8 lacs).
Even though the NAV of your fund has doubled, your investment has not doubled.
What should you do?
I do not deny that my view is biased.
I prefer to keep my investments and insurance separate and do not like ULIPs and traditional plans much. High charges, lack of flexibility, difficulty in exit and lack of portability.
However, even with my biases, we can easily see how and why age affects returns. The impact is higher for an older person. Hence, if you are old, avoid ULIPs.
Elderly persons or retired persons make for easy targets to sell these kinds of plans. For such people, these plans are a double blow. Firstly, they may not need life cover and hence there is no point paying for life cover. Secondly, there is no point paying so heavily for the life coverage. This dampens your returns.
Another point to note is that if you have an existing illness (at an old age, you are likely to have an illness), your mortality charges may even get loaded (increased due to illness). This will dampen your returns further. Here is an egregious example where an investor ended up with Rs 11,000 after investing Rs 3.2 lacs over 6 years in a ULIP. In a ULIP, NAV is not affected. Only the number of units that you own goes down.
If you keep insurance and investment separate, you will not face this issue.
Keep things simple.
Despite what I wrote, you may find merit in a ULIP or a traditional plan. This is fine. I have also written about situations where these combo products can add value to your portfolio, especially non-participating traditional plans. However, you clearly do not want to base your decision looking at illustration for a 25-year-old when you are 45.
This post was first published on August 17, 2017 and has undergone revisions since.
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This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.
