B U S I N E S S

personal finance
Inflation Indexed National Savings Securities
A saving instrument that provides protection to investors against inflation
Dr Sanjeev Bansal
The RBI is set to unveil Inflation-Indexed National Savings Securities-Cumulative (IINSS-C), benchmarked against the Consumer Price Index (CPI). At a time when investors are stranded witness to high retail inflation of around 10-11% eating into their return on investments in various asset classes, the announcement comes as a saving grace.

Lapsed insurance policy could cost you dear
Amit Kumar Roy
After long deliberations, exhaustive comparisons and spending so many man-hours while deciding to buy the policy what suddenly goes wrong that one decides to discontinue the policy? I have come across enough reasons for a lapsed policy and interestingly all reasons sound genuine — or at least they are communicated in a manner that the policyholders’ decision to discontinue the policy sounds convincing.

personal finance
Inflation Indexed National Savings Securities
A saving instrument that provides protection to investors against inflation
Dr Sanjeev Bansal

The RBI is set to unveil Inflation-Indexed National Savings Securities-Cumulative (IINSS-C), benchmarked against the Consumer Price Index (CPI). At a time when investors are stranded witness to high retail inflation of around 10-11% eating into their return on investments in various asset classes, the announcement comes as a saving grace. Investors are cautiously evaluating options that can generate a positive real rate of interest. During the past few weeks, they have been quick to latch on to the tax-free bonds offering interest rates of up to 9.01%. While the RBI launched inflation-indexed bonds (IIB) linked to the wholesale price index (WPI) earlier this year, the upcoming IINSS-C to be launched this month will be benchmarked against the CPI which is a better indication of the retail inflation and therefore will more realistically provide protection against inflation.

As of now, fixed deposit instruments by banks and post offices are offering around 8.6-9.2%, the BSE benchmark Sensex has risen by around 7.8% in the past one year while gold has generated a negative return of 10.9% in the same period. This product comes as an attraction for investors offering returns that are far superior to them.

The product

The 10-year bonds are meant for investing only by retail investors i.e., individuals, Hindu Undivided Family (HUF) and charitable institutions and investors can invest a minimum of Rs 5,000 while the investment amount can go up to Rs 5 lakh per investor. The product offers interest in two parts — the inflation rate and a fixed rate of 1.5%. It has been structured in a manner that even if the inflation goes into negative, investors will continue to get 1.5% which is a fixed rate. The fixed rate of 1.5% will be paid six monthly and investors will get the compounding benefit on the six monthly interest. At redemption, they will get both the principal and the compounded interest rate. The inflation rate for a month will be based on the combined CPI of the month preceding three months.

The mechanism

Say, you invest Rs 1,000 in a normal bond which also offers a rate of 1.5% annually and matures in one year. After a year, you get Rs 15 as interest and the original investment of Rs 1,000 is repaid. There is no uncertainty here. Now, an inflation indexed bond, of the kind being issued by the RBI, with the same terms, will give you more or less — depending on the level of inflation or deflation. Assume, for instance, that over the next year inflation is 9%. The inflation indexed bond will give you Rs 16.35 as interest.

On the other hand, if there is 9% deflation (price decline), your interest falls to Rs 13.65. On maturity, along with the interest, you will be repaid the original investment or the revised principal amount, whichever is higher. So, if inflation is 9%, the amount you will be returned (besides interest) at the end of the year will be Rs 1,090. If prices fall 9%, the principal repayment will not be reduced to Rs 910; you will still be paid the original investment of Rs 1,000. This way, inflation indexed bonds protect both the principal invested and the interest against inflation. In a deflationary scenario, the interest you receive will reduce, but the principal invested will be returned intact, given that the bonds carry capital protection.

The positives

This latest financial instrument has many positives to its credit. As inflation has been high in India in recent years, one can ensure good returns and protection from inflation by investment in IINSS-C. The safety of the principal is not a cause of concern as the bonds are part of the government’s borrowing programme. IINSS-C will be considered on par with sovereign rated government securities (G-Secs). Even though IINSS-C will be taxed like fixed-deposits (FD), the interest can be substantially higher than FDs during a period of high inflation. Conversely, the returns can go lower than FDs when inflation is low.

Third, the product should be easy to purchase from banks; servicing it should not be an issue due to bank involvement. Early redemption of IINSS-C, after expiry of the lock-in period will ensure that you get back your principal even if inflation falls drastically; but you will take a beating due to the penalty on the coupon rate. It works more like bank FDs which have a penalty on premature withdrawal. Fifth, IINSS-C should dissuade savers from buying gold for investment purposes.

The negatives

The instrument is not free from some negatives. First, the bonds are meant to be long-term savings instruments. They will not be tradable in the secondary market. Liquidity is certainly an issue with IINSS-C; bank FDs are completely liquid; some banks do not even have a penalty on premature withdrawals for all FDs or depending on the tenor of the FD. Second, early redemptions will be allowed after one year from the date of issue for senior citizens (those above 65 years of age) and three years for all others, subject to penalty charges at the rate of 50% of the last coupon payable for early redemption. For example, if you redeem after the third year, you lose half the interest of the previous year. Early redemptions, however, will be made only on coupon dates. Hefty penalty for early redemption is a major deterrent; but bank FDs too have premature withdrawal penalty of 1% lesser interest rate than the rate offered for the period for which the FD was kept.

Third, IINSS-C does not match the charm of public provident fund (PPF) which allows Rs 1 lakh investment in a year for tax deduction under Section 80C. Moreover, interest on PPF is tax-free. IINSS-C may not even score over tax-free bonds, especially for savers in the 30% tax bracket.

Fourth, rate of interest on IINSS-C will be floating which may not be suitable for those in need of fixed income. Moreover, the absence of income flow can make the product unattractive for senior citizens. Bank FD interest is compounded quarterly for the cumulative as well as non-cumulative option. Fifth, tax treatment on interest and principal repayment would be as per the extant taxation provisions. Tax will be levied on the interest as per your tax bracket, which is in line with bank FD. The product is suitable for those in the lower tax bracket (up to 10%).

The author is a professor, Department of Economics, Kurukshetra University, Kurukshetra. The views expressed in this article are his own

Lapsed insurance policy could cost you dear
Amit Kumar Roy

After long deliberations, exhaustive comparisons and spending so many man-hours while deciding to buy the policy what suddenly goes wrong that one decides to discontinue the policy?

I have come across enough reasons for a lapsed policy and interestingly all reasons sound genuine — or at least they are communicated in a manner that the policyholders’ decision to discontinue the policy sounds convincing.

However, it is never advisable to discontinue a policy overnight and let all the premiums paid go in vain. These premiums are your hard-earned money. Unfortunately, when people are in a financial muddle, the life insurance premiums are the first ‘expense’ that is stopped without realising that this was a ‘compulsive saving’. While there is enough data on lapses that can be shared, the intent here is not to bombard you with the same but focus on the impacts and consequences of a life insurance policy lapsing.

The policyholders are supposed to pay the premiums by a defined date which is agreed and documented in the policy document. If the premiums are not paid even in the grace period then the policy is treated as lapsed. Generally, after the due date, there is a grace period of up to 30 days to pay the premium. In case of unit-linked insurance plans (ULIPs), if the policy lapses the accumulated amount goes in the ‘discontinuance fund’. Once the accumulated amount goes into the ‘discontinuance fund’, it does not participate in the market and is treated like ‘money in any savings account’. As per the regulations, it earns a nominal interest.

As per the terms and conditions defined for revival of policies by the regulator and the respective life insurance company, the policies can be revived. However, if a lapsed policy if not reinstated within the reinstatement period, it gets terminated without any benefits. The ‘first’ and the ‘biggest’ loss is ‘the life insurance cover’. As soon as the policy lapses, as per the contract, the life insured loses the ‘sum assured’ cover and in case the death happens in this stage of the policy, the life insurance company is not liable to pay the promised sum assured. The loss next in line is the ‘loss of the premiums paid’. If the policy is lapsed and the life insured wants a refund, the refund, subject to the terms and conditions defined by the regulator and the company, is paid.

Over a period of time if the life insured plans to revive the policy, he/she may have to undergo a health checkup again subject to the plan and the sum assured. In case the health has deteriorated, the life insurance company can ask for an increased premium or can even reject the application for revival.

Even if the life insured is healthy and plans to buy a new plan, he/she should realise that due to higher age the mortality charges (cost of life cover) will also be high leading to an increased premium.

Hence, to avoid going through this rut, make sure you buy a policy that you can afford and suits your needs too. If the policy has a long-term premium-paying term, make provisions for it instead of allowing it to lapse which would turn out to be more expensive and loss-making proposition.

There can be times when your expenses are more than your earning and you have to take a decision to prioritise the expenses. As you take that tough decision, do remember that life insurance is for living and not for dying. It is for those who would continue to live after you are gone.

The author is Chief Agency Officer, AEGON Religare Life Insurance. The views expressed in this article are his own