Tuesday, November 13, 2012

Why avoid Endowment Plans


Recently the writer was approached by a SDM of an insurance company with a proposal to take up agency of their company and sell insurance policies. Traditional plans was to be the focused upon. With ULIPs losing their appeal (since with cap on costs, the commission has also been reduced), traditional plans are being pitched aggressively..

Traditional plans are back in vogue. Not because they help the investors meet their long term goals, but because it pays big commissions to the agent. A traditional plan currently pays nearly 30% of the first year’s premium as commission apart from other emoluments to the insurance agent. It’s time the investor ask themselves:- Does endowment policies serve any purpose? If not are there any alternatives? Let’s try to find out.

Let’s take a hypothetical example of Anuj who is a 30 year old male—who wants to build a retirement corpus when he turns 60. His Endowment policy would look as under:-

Tenure                                                 30 years
Sum Assured                                      10 lacs
Annual Premium                                 Rs. 30,723(including Service Tax)
Maturity amount                                  Rs. 21.46 lacs(at 6%)       

The following conclusions can be drawn from the above information:-

Annual Premium outflow                     Rs. 30,723/-
Premium payment term                      30 years
Death claim payable                           Rs. 10 lacs
Likely maturity amount                   Rs. 21.46 lacs (plus loyalty bonus if any)

Let’s calculate the interest earned on this payment. Rs. 30723 paid for 30 years becomes Rs.21.46 lacs

The formula for Rate is (nper,pmt,pv,[fv],[type) where
                                                                Nper is the period of payment
                                                                Pmt is payment per period
                                                                Pv is the present value of the payment
                                                                FV is the future value receivable
                                                     Type is payment at beginning or end of period

Substituting the values in the equation for Rate= (30, -30723,0,2146000,0),R is calculated to be 5.3%. Is this rate good enough to justify your hard earned money? We believe the only reason people buy endowment plan is for compulsory savings that such plan tends to demand of them. Insurance cover is a bye product that they get—which any how is minuscule and irrelevant. It also gives the investor a mental satisfaction that they have done financial planning (?) for their family.
   
The basic premise of an endowment policy is insurance+returns. So let’s try to work out a combination ourselves which will be better than the endowment and yet costs less.

A.     For a Highly conservative Investor

Term Assurance for Rs. 30 lacs for 30 years---Rs. 8676/- per year.(incl. service tax)
 Invest Rs. 22000 per year in PPF for 30 years--- Rs. 26.90 lacs.
 Amount Invested: -   Rs. 30676 per year (8676+22000)      
             Death Benefit       : - Rs. 30 lacs+PPF
             Maturity Benefit: -  Rs.26.90 lacs (PPF maturity)

B.      For An Aggressive Investor

Term Assurance                               Rs. 50 lacs—Rs. 12600/- p.a.
Investment in MF through SIP: - Rs. (30000-12600) -- Rs.17400/-               
(returns assumed 15% CAGR)

Death Benefit                    Rs. 50 lacs+Mkt value of investment.
Maturity Benefit              Rs. 1.05 crores (Mutual Fund maturity) 


Hence, it is advisable for people who have taken an endowment policy to convert it to a paid up policy and divert the current premium in one of the options as above (depending upon your risk profile). However, if the term of the endowment policy is nearing maturity, then let it run to maturity.

Insurance is supposed to replace your income in your absence. It is not supposed to supplement it. Insurance is not designed to generate returns, but manage risk. There are other products for investments. People are advised not to get lured by the fancy features of the policies and exotic excel illustrations. Judge the policy by your requirements and not that of the agent’s.



Disclaimer:- The figures used above are for illustration only. The exact figure may differ from those above. Premium figures are that of HDFC Standard Life Insurance Co. Ltd.
Views expressed are personal views of the writer. Investors should use their own judgment and discretion while evaluating their requirements. It is advisable to appoint a certified planner for impartial professional advice.

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