Rising interest rates usually mean higher returns for investors. But today it has resulted in investors losing out as the net asset value of unit-linked plans -- both of mutual fund schemes and insurance plans -- have taken a dip.
Investors of unit-linked insurance plans have seen NAVs slip by 2-3 per cent. For mutual fund debt schemes the decline has been greater depending on the kind of investments.
The fall in the NAV is simply a reflection of the 10 per cent drop in bond prices since the beginning of the financial year 2004-05.
What was once perceived as the safest and most conservative form of investment, the income fund option ULIP, is today churning out negative returns.
This is despite many insurance companies selling off their long-term securities and opting to buy shorter-term paper despite having long-term liabilities.
"We took a call on interest rates and decided not to hold paper of more than one and a half year duration. This means we can now invest at higher yields," says B Natraj, director & chief operating officer, AMP Sanmar Life Insurance Company.
His is not the sole insurance company to do. All insurers offering ULIPs have invested in short-term paper, and even today are reducing the duration of their investments as they expect interest rates to rise further.
So what does all this mean for the policyholder who suddenly sees the value of his long-term investments falling and returns turning negative?
In vast contrast to the banking sector, insurance companies actually stand to gain from the steepening yield curve as fresh inflows from policyholders -- in terms of annual or monthly premium -- will be invested at higher interest rates. This will in effect result in higher returns for policyholders.
Of course, if a policyholder's cover were to mature today when the NAV is down or has turned negative. His family would tend to lose out.
Birla Sun is among the few insurance companies, which guarantees a three per cent annual return on the net investible portion of the premium. That means, a policyholder will not lose out even if the investment climate turns sour at the time of settling his claims.
"Policyholders should not take a call on short-term movements in interest rates. An insurance policy is a long-term contract. Yields may go up or down today, but my liability is at least of five years," says Peter Akers, chief operating officer, Birla SunLife Insurance Company.
What's more as insurance companies continuously decrease the duration of their investment portfolio, the fall in the NAV correspondingly drops.
Last year ICICI Prudential Life's average portfolio duration was five years. Today it has been dropped to less than three years, with the idea of reducing the fall in returns.
"We launched a Preserver Fund at the end of April with the sole objective to preserve capital. Investments are made in short-term instruments like commercial paper of three to six months maximum. We have seen a number of our policyholders switch to this scheme," says Puneet Nanda, head of investments, ICICI Prudential Life Insurance Company.
Every one percentage rise in yields means a fall of 100 basis points on the NAV, on an average. The NAV of ICICI Prudential Life Insurance's Income Fund Protector fell by 2.92 per cent from Rs 13.72 on March 31, 2004 to the current Rs 13.32. Similarly, the NAV of Birla SunLife Insurance's Protector Plan dropped to Rs 12.75 on Wednesday from Rs 13.1 as on July 31.
With NAVs dipping and interest rates expected to see further upswing, investors have turned proactive. Till March, more than 60 per cent of those who opted for ULIP decided to invest in income funds, and just 25 per cent in balanced funds, and 15 per cent in equity funds. Recently policyholders are shifting their investments, favouring balanced funds.
"About 50-60 per cent of fresh premiums are now invested in our balanced fund as opposed to 25 per cent earlier," says Nanda.
