Low Annuity Returns in India

21 comments Written on January 16th, 2010 by
Categories: Insurance, Pensions

Why are annuity rates in India so crappy?

(Annuity: Pay a lumpsum now and receive a fixed income for the rest of your life)

image

This is the return for a 50-lakh rupee annuity, purchased at age 60.

LIC provides an annuity that returns your entire purchase price ('principal’) to your next-of-kin when you die. This – as you can see above – provides a return of 7.50% or so per year. And the income is taxable.

Let’s look instead at buying a 25 year government bond – the principal is protected and returned at the end. The bonds are available for a yield of about 8.30% – which means for a 50 Lakh purchase, you can get back 4.15 lakhs per year (again, taxed).

All LIC has to do is buy 25 year maturity government securities and rake in the Rs. 40,000 per year extra that they make. That’s equivalent to paying 11% commissions, every single year!

A counter argument is that LIC is getting paid “managing” the money. Bollocks. This is ONE BLOODY TRADE, that’s it. What if the person lives to beyond the 25 year term, you ask? (Since LIC has to field that risk) First, average Indians do not live up to 85 years old (which is when the product matures) and last, the rollover trade to higher maturities is very possible without a loss. And 11% to do this? Excuse my sputtering, but this is frikking ridiculous.

[Annuities are important if you are considering the New Pension Scheme (NPS). At retirement (60) you will need to buy an annuity with 40% of the corpus. ]

Good business if you can get it, though. But in the face of competition have private insurers not tightened things up?

Most other insurance companies don’t offer this kind of “return of principal” – they just take your money and give you a pension till you die. When you die (and in some cases, when both you and your spouse die) the money flies to the big hole in the sky. Rates of return for such annuities vary from 5.8%  to 9.7% per year; the maximum I could see for a 60 year old was about 4.87 lakhs per year at LIC. (50 lakh purchase). Some private insurers offer just 5% returns, so forget the “competition” business.

How does this work? They could buy Government bonds and for the excess return (above 8.30%) redeem a part of the investment and pay the annuity. The average Indian is expected to live till around 65 years of age. Even if you consider an average lifespan of 75 , the “redeem the excess” strategy will leave Rs. 30 lakhs as the insurer’s profit when the pensioner dies.

(This is assuming the insurer just buys government bonds, just so you can understand how profitable the business is. You can get this kind of return yourself, with very little effort. Insurers have better options and much higher return capabilities beyond the above mentioned bits.)

Like I said, good business if you can get it. It’s time we got a financial player that really squeezed the margins and provided good products. If we get rid of overheads – excessive commissions and other bull – paying less than 1% a year as intermediation costs will become a reality. Financial products are usually sold, not bought; but it doesn’t mean that will not change (“Selling” means commissions, means higher cost and all that). It is truly unfortunate that doing this business requires so much money upfront – becoming an insurer, for instance, needs a net worth of Rs. 100 cr.  - or I would be doing it. It’s an option I have explored, is on the radar and currently out of my reach financially. But I’m biding my time.

Related Posts Plugin for WordPress, Blogger...
About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@capitalmind.in.

21 comments “Low Annuity Returns in India”

>This is why I hate NPS. I also hate you for encouraging the immature NPS in this post ;)

People will take your advice. Amass untold wealth in theory using low charges of NPS. And lose all of it to annuity providers.

>Good one Deepak

The way LIC is making money is what I can call "madness of Trust" . People just do not take paper and pen and calculate things . All hell will break loose if investors start doing it .

How difficult do you think is getting 8-9% return from principle at retirement .A simple approach I can find is combination of these

- 20-25% money in large cap good and consistent dividend paying companies (tax free) .
- 25% in Investment in Senior Citizen saving Sceheme
- 25% corpus in some Annuity
- Rest in MIP's with majority in Debt .

Manish

>One more option for regular Income in retirement age might be Postal MIS.

Now current limit is 9 lakhs for joint account which pays 8% ROI and 5% bonus on maturity.

If you got more money, put 15 lakhs in senior citizen's scheme http://oldagesolutions.blogspot.com/2009/08/senior-citizen-savings-scheme-scss.html

which gives 9% ROI and quarterly interest.

Either try multiple accounts like one with you and your kids, one with you and your parents (not sure if this is allowed).

There must be some facility where you take some money out from pension pot in phased manner which might not be taxable for that FY. (income draw down – not sure about this term).

Hope tax free income limit might grow by that time (tax code might have removed this feature though)

I got around Rs 55 / thousand per year from LIC in year 2004 for some of old firms some scheme where they pay to LIC. Its is around 5.5 % which quite less that prevailing interest rates in Aug 2004. This is not exactly annuity but similar sort of thing which also depends upon you age.

>That's an eye opener.

Thanks
Yogi

>Manish and Oracle, while your advice is good, you are missing the real reason these low-yield annuities are used:

1. At times it is cAnonymous Bingo said…

Manish and Oracle, while your advice is good, you are missing the real reason these low-yield annuities are used:

1. At times it is compulsory. To get your superannuation funds, there is no option to withdraw all of it even if you are ready to take the tax hit. For a certain percentage (33% to 50% in different cases) you have to take an annuity.

For this purpose, LIC and ICICI pru are the only companies from which you can take an annuity plan. There is no free market which might bring up the annuities yields. It is a Govt granted duopoly to these 2 companies.

2. There is a huge tax-hit if you do not take annuities in certain cases. Like NPS withdrawals are taxed at retirement as if they were income in the year of withdrawal. Except if you opt for these shitty annuity schemompulsory. To get your superannuation funds, there is no option to withdraw all of it even if you are ready to take the tax hit. For a certain percentage (33% to 50% in different cases) you have to take an annuity.

For this purpose, LIC and ICICI pru are the only companies from which you can take an annuity plan. There is no free market which might bring up the annuities yields. It is a Govt granted duopoly to these 2 companies.

2. There is a huge tax-hit if you do not take annuities in certain cases. Like NPS withdrawals are taxed at retirement as if they were income in the year of withdrawal. Except if you opt for these shitty annuity schemes.

>dear all,
A very good comments by mr. manish.
Every word is true.
Donot forget any annuity receivables (2/3 rd) is TAXABLE income.fmc or fund magt. charges on the corpus are a real PROFIT to the fund houses.
kindly also remember annuity is the reverse of life insurance.
thanks for this service.

>i fully agree with mr . bingo.
wellsaid sir !
keep the good work gooing.

>Manish

u can't invest money for retirement now in a senior citizens scheme bcos u r not a senior citizen.

Also 20-25 % in large cap good consistent companies would have included companies like mafatlal industries, arvind mills etc at a point of time. These were the true blue blooded blue chips. I m sure it wasnt great to lose money on Bharti suddenly. It still remains a great company but a bad stock

>One big flaw in your calculations is you dont take into consideration the movements in Interest rates.

But, the issue we have is, nobody does this kind of analysis. This is an eye opener, am looking forward to more posts like this – that can bring out more of these 'trades' that big firms do. its a goldmine now for these folks, 99 percent ppl do not understand whats happening.

MrDalal .

>Hii
Deepak , I really love u for this article ,However if you Analyze all the plan with lic its about the same …

Cheers

>very nice analysis, but is it not that the minimum amount required to subscribe to these (GOI)bonds is in crores, and they have very long lock in period. if i am wrong please correct me, and how do we purchase them. also do u have info regarding the RBI bonda for retail investors? i think they used to have something, but i dont recollect the same anymore.

>Aman: No, the minimum is Rs. 10,000 (and multiples of Rs. 10,000). THere is no lock in – you can sell them the next day on the open market…

>As said that LIC is only company which returns the corpus. Kindly be informed, ICICI Prudential returns the corpus after death under two options: Life annuity with return of purchase price, Second: Life annuity with last survivor with return of purchase price. It is important to note that though it is true that the money is invested in excess returns bond but, the pension is offered as a fixed rate pension even in the scenario of interest rates movements especially upwards becasue at that time the bond will be priced low or yeild will go down and then it will be difficult to sustain the committed rate. It is true that there are no free lunches in this market. At last, though the average longivity is 65 years as one said but, data says that it is going to increase and could touch above 75 years. So, if I am alive and getting pension then why should I bother about that money which the company makes…once eyes are closed nothing is for me. And if I have taken the return of corpus option that money will come back to my nominee. What is the wrong in it?

>Anon: What's wrong is that there are much much better options out there, therefore these insurers are cheating people out of their money.

Even at an expectancy of 75, these insurers make too much profit.

I checked ICICI, and you get a miserable 6.2% when you choose return of purchase price at age 60. That's ridiculous – you can get 2% more, investing in government bonds!!!!

Right now the insurers are getting a free lunch. Need to stop this. What's wrong in it is that people are getting cheated out of their retirement money.

>ALL THOSE WHO HAVE POSTED THEIR COMMENTS
FOR YOUR INFORMATION LIC IS ALSO PAYING INTEREST AT THE RATE OF 12% IN JEEVAN AKSHAY PLAN SINCE 1990 TILL TODAY (THE PLAN IS NOT AVAILABLE FOR NEW SUBSCRIBERS) BUT THOSE WHO HAVE ALREADY INVESTED ARE GETTING SAME YIELD OF 12% IN FALLING INTEREST RATE SCENARIO.IN OTHER ANNUTIY PLANS LIC I SPAYING ANNUITY WITH RATE IN THE RANGE OF 9 TO 10% PLEASE REFER JEEVAN DHARA & JEEVAN SURAKSHA PLANS OF LIC
INSURANCE COMPANY IS TAKING LONGTERM INTEREST RISK IN ANNUITY PLANS & WHENEVER THERE IS CAHNGE IN INTEREST RATES LIC COMES WITH NEW VERSION OF JEEVAN AKSHAY PLAN

>This is one of the reasons I'm not going to invest in the NPS – the other is that I want to invest in 100% equity. The NPS only allows me 40%.

I think when I retire I'm going to go for some MF debt scheme….

>dear all,
kindly note bonuses from lic came down from 16% (1990 year) to 6.5 % from 2005 year onwards.
kindly check any endowment policy, with profits ,,started by my brother in 1990, maturity benefited received in 2010 july.
the irr or tax free returns are 9 % only.
even if you see the death benefit is 1.5 lacs for 10,000 rs annual premium.
we have no time or interest to CROSS CHECK.
thanks for this service.

>best way to tackle retirement is long term FD.At current rates a 2 lakh FD for 10 years would return 5 lakhs.If i know i am going to retire after 10 years i would do a FD every year for 10 years and each FD would keep maturing every other year.

YES Bank is offering 10.6% Returns to senior Citizens on FD. This appears to be the best rate on safe investments.

Exactly the reason why I don’t like NPS. And another factor is that you are forced to buy annuity at the time you retire, even if the market condition is not favorable. You are locked for life.

Nice Article..Thanks for opening my eyes Deepak :)