Why are annuity rates in India so crappy?
(Annuity: Pay a lumpsum now and receive a fixed income for the rest of your life)
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.