Went in for a reality check? Run for cover

Bonuses declared by insurance companies this financial year have not been
good.

Investors look forward with great expectation towards the bonus declared by insurance companies on their various policies. FY04 has not been very bright for those holding participatory policies of life insurance companies.

In these policies, the investor gets the benefit of bonuses from the earnings of the insurance company.

Falling yields on government securities has caused a fall in bonus rates across almost all insurance companies, by at least 50 to 100 basis points, as compared to the previous year.

What this means for investors is that they need to check and maybe, even adjust their calculations accordingly.

Market leader, LIC (Life Insurance Corporation of India) has cut bonus on its whole life and endowment plans by around 1%.

This low bonus has prompted LIC to announce a shift in investment approach and focus on equities. Private insurers are not doing too well either. They have also declared lower bonuses. This low bonus, coupled with rising inflation, makes returns paltry.

Participatory policies are highly regulated so far as their investment patterns are concerned. The equity component is restricted to 35% of total investments, thus, driving most investments into government securities and bonds, which are considered fairly safe and till some time ago, provided reasonable returns.

Further, most companies preferred to keep their equity exposure in these kinds of plans up to 20-25%, not using the full leverage opportunity offered by the regulator. Participatory plans are looked upon by the customer as safe and hence, it was important to maintain capital, while giving reasonable returns.

But with the rise in interest rates, g-sec yields have taken a hit and the returns in the form of bonus for FY04 fell. In the case of HDFC Standard Life's Whole Life Plan, the bonus was 8% in FY02. It fell to 7% in FY03 and was 6% for FY04.

Similarly, in the case of Kotak Mahindra Old Mutual's endowment type of policies, the bonuses fell from 7.5% last year to 3.5% in FY04.

While the poor debt market has hit participatory policies, debt-oriented, unit-linked policies have also suffered. NAVs of many debt-oriented funds have dropped drastically. The advantage that these policy holders have is that they can choose to switch between fund options for free.

When the debt market does not look very bright, they can switch to an equity option. Subsequently, having built up a healthy fund balance, they can switch back to debt to maintain capital.

However, policy holders of participatory policies don't have this much choice. If they plan to exit, they stand to be charged a heavy surrender penalty.