13/08/2010 Endowment plans are bad investments…

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Endowment plans are bad investments
Which small car is
Published: Wednesday, May 19, 2010, 22:52 IST Volkswagen planning to
By Vivek Kaul | Place: Mumbai launch in India in 2010?

Speak Up »
+ -
The recent spat between the Living life in the shadow of
Insurance Regulatory and Ads by Google death
Developm ent Authority of India (Irda), Compare Life Insurance
the insurance regulator and the Insurance IrDA Interview »
Securities & Exchange Board of India Aetna Insurance Plans
(Sebi), the stock market and the Endow ment Insurance ‘There is a robust appetite
m utual fund regulator, seems to have for dollar bonds of Indian
hit the sales of unit-linked insurance banks’
plans (Ulips).
View more interview s »
Agents and insurance companies are
now prom oting endowment insurance
Blogs »
plans instead of Ulips. But these
remain a bad form of investing. To
I hate doctors
know why, read on.
- Anthony D'Costa
What is endowment insurance plan?
In an endowm ent policy, the policyholder is insured for a certain amount,
referred to as the sum assured. A portion of the premium goes towards this
insurance cover. Another portion helps m eet the administrative expenses of View more blogs »
the insurer. And a third portion is invested by the insurance company on
behalf of the policyholder. The return the insurance com pany m akes on the
invested portion is distributed to policyholders as an annual bonus. The Opinion »
annual bonus is declared as a proportion of the sum assured. So if sum
assured is Rs 10 lakh and a bonus of Rs 5 per Rs 100 sum assured or 5% Fix the problem, then the
is declared, the insurer is effectively declaring a bonus of Rs 50,000 (5% of blame
Rs 10 lakh). The bonuses rarely go beyond 5-6% prim arily because the Move CRPF away from
investments are made in relatively safe debt securities. Since the risk taken Kashmir’s streets
is low, the return generated is also low.
A creditable bronze medal
How agents mis-sell it? for Mr Decent
Let us consider an endowm ent policy of 25 years, with a sum assured of Rs
10 lakh, taken by 30-year-old individual. The annual premium on such a
policy will work out to around Rs 40,000. So if an insurance com pany
declares a bonus of 5% on the sum assured, it would mean a bonus of Rs
50,000. Now, Rs 50,000 is greater than the annual prem ium of Rs 40,000.
And if a company continues to pay a bonus of greater than Rs 40,000 every
year, the bonus being paid will be greater than the annual premium . This
feature of the endowm ent plan it what the agents turn into a marketing
gimm ick. A typical agent is likely to tell you, “Sir, the insurance com pany
always declares a bonus of more than 4% (Rs 40,000) every year. So the
bonus you get every year will be more than the annual premium you pay to
the company. Isn’t that marvellous?”

Here’s what the agent does not tell you

The agent works for the insurance company and not you. Hence, he does not
tell you the real thing. What you, as policyholder, do not know is that the
bonus, unlike a dividend, is not paid out every year. The bonus accum ulates
and the policyholder gets it along with the sum ass ured at the maturity of the
insurance policy. So let’s extend the exam ple above. Assum ing the policy
declares a bonus of 5% every year, over 25 years, you will get a bonus of Rs
50,000 every year.So at the end of 25 years, you will get Rs 12.5 lakh as
bonus (Rs 50,000 x 25). You will also get the Rs 10 lakh sum assured as
well, for a total of Rs 22.5 lakh (Rs 12.5 lakh + Rs 10 lakh).

So what is the problem?

The biggest problem with the bonus is that it does not compound, and is
m erely an accounting entry that accumulates. What this means is that in the
above example, the bonus of Rs 50,000 would stay at Rs 50,000 till the 25th
year, when the policy matures. This would be true of all bonuses declared
during the term of the policy (if they are declared). So if you survive the policy
period, the insurance com pany would give you Rs 22.5 lakh in total.

What are the returns you can expect?

A payout of Rs 22.5 lakh at the end of 25 years, would im ply a return of 5.78%
per year, which isn’t great shakes by any stretch of im agination. Even if we
were to assum e an average bonus of 6% every year, the total am ount paid at
m aturity would am ount to Rs 25 lakh (Rs 10 lakh as sum assured + Rs 15
lakh as bonus) with a return of 6.48% per year.

Is there a better way to go about it?

The moral of the story is that the point about bonus paid out during a given
year being greater than the premium paid, isn’t really relevant. It is just a m is-

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13/08/2010 Endowment plans are bad investments…
selling trick.

A better way to go about would be to take a term insurance policy

of Rs 10 lakh and invest the remain-ing m oney (i.e. the difference between
the premium being paid in case of the endowm ent policy and the premium
paid on the term policy) into the Public Provident Fund (PPF), which
guarantees an interest of 8% per annum. A term insurance cover of Rs 10
lakh in this case will cost around
Rs 3,200. If the rem aining Rs 36,800 is invested in the PPF account earning
8% every year, at the end of 25 years, a corpus of Rs 27 lakh will accum ulate.
This is Rs 4.5 lakh or 20.5% more than Rs 22.5 lakh.

Of course, the advantage of taking on term insurance is that by paying a little

m ore money you can also increase the am ount of life cover. By paying
around Rs 4,600 per year, the policyholder can get a term insurance with a
cover of Rs 15 lakh. This is Rs 1,400 m ore than the premium for a cover of
Rs 10 lakh. An endowm ent insurance plan will require a premium of Rs
15,000-20,000 m ore over and above, the annual prem ium of Rs 40,000.

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