Endowment Policies – when it comes to maximizing returns

“Back in July 2002, I took an endowment policy. I was in my first job and for the first time in my life I was submitting investment proof to claim the munificent tax rebate. I had heard from someone that taking an endowment policy would be a better option as the higher premiums I pay would take me near the magical, tax rebate figure of One Lakh and to top it, I would get good returns on policy maturity! I didn’t think twice; called up an insurance agent. All he told me was about endowment policies. Finally, for an annual premium of around Rs. 21,000, I took an endowment policy with a policy term of 25 years. The rest I managed with National Savings Certificate.”

“It’s been three years and having diligently paid all the premiums, now I am a loyal customer of the insurance company. But some of my colleagues who had invested in stock markets that time, directly or through Mutual Funds, have already tripled or quadrupled their savings. Some had made even more. That’s when I started thinking about my endowment policy and the kind of returns it gave me with respect to the investment I made in the form of premiums. Is my endowment policy actually giving me good returns?”

I’m sure most of us who own an endowment policy would have thought like this at least once. This post succinctly examines the same. In the due course, we will find out how endowment policies don’t give much returns or insurance cover vis-à-vis some of the other investment opportunities.

Let’s have a closer look at Endowment Policies. Endowment Policies by definition agree to pay a lump sum on maturity while giving a small insurance cover during the policy term. Thus it’s a combination of both insurance and investment. The policy holder pays premium (this is the investment) reasonably higher than a term-insurance policy and gets yearly bonuses from the insurance company that get accrued and added to the lump sum. On the event of death or on maturity he gets the sum assured plus the accrued bonus (both constitutes the return on investment), which according the insurance company or the agent, is a formidable amount.

Thus, on policy maturity, the policy holder gets money in two ways.

Every year,
a) Reversionary Bonus: Distributed from company profits, based on plan, term and sum assured.
b) Terminal Bonus: Distributed from company profits for customer loyalty, based on plan, term and sum assured.

On maturity
a) Sum assured

So that the Total Amount on maturity = Sum Assured + Accrued Annual Bonuses.

Now let’s study an endowment policy in detail to calculate the returns from it. The policy under study has the following parameters.

  Annual Premium = Rs. 21,000
  Policy Term = 25 years
  Premium Paying Term = 25 years
  Sum Assured = 5 Lakh

Bonus declared by the insurance company for this particular policy during the years 2003-04, 2004-05 and 2005-06 were Rs. 53, Rs. 47 and Rs. 44 respectively, for every thousand rupees sum assured, i.e., an average of Rs. 48. Though I understand that the bonus amount would vary from year to year and may increase in the coming years, I take this average value for the calculations. Also, please to note the decreasing trend in bonus amount.

Thus for a sum assured of Rs. 5 Lakh, the bonus would come out to be Rs. 24,000 per year which is Rs. 6 Lakh for 25 years.

The terminal bonus is usually not made public by the insurance company. Hence we have no other way but to assume it to be on the range of Rs. 4 Lakh.

That makes the total amount the above policy holder would get after 25 years to be Rs. 15 Lakh. And the total premium he would have paid during the policy term would be Rs. 5 Lakh [21,000 X 25]. Thus the policy gives him an annualized return of 12%. [((15 / 5) X 100) / 25]

In this way you can calculate the returns you get from your endowment policy.

Now we got an idea about the returns from an endowment policy. Going ahead, let’s think about the next question. Is there any other way for us to get more returns and more insurance cover from the same investment amount? Is there a way to maximize our investments without compromising on the insurance cover?

So, let’s look at another investment option; say Mutual Funds. Over the years, mutual funds have been giving very good returns, in the range of 40% per year. But if we assume an average return of even 15%, an investment of Rs. 21,000 per year for 25 years would give the above person a return of Rs. 51 Lakh, had he invested the same amount in Mutual Funds every year! Quite amazed?

Unlike endowment policies, mutual funds don’t give any insurance cover. So how do we take care of the insurance part? Well, one way to do that would be to cut down the investment amount a bit and take a term insurance using that. Just to give you a hint, for an annual premium of around 6,000 rupees you will get a term insurance of about Rs. 25 Lakh for the same time period of 25 years! Hence splitting the endowment policy into term insurance + mutual fund combination would be an intelligent way to get more returns and insurance cover. When you play around with such a combination, probably you would end up with a better investment, having more returns and more insurance cover for the same investment amount.

Now one may ask, with endowment policies he will get a return for sure but if he invests in mutual funds, isn’t there a risk of losing money? Well yes, since the mutual funds invest in shares there is a risk of losing money. But mutual fund companies maintain a portfolio of shares to reduce this risk, due to which the downfall may be less. Also, for the less risky, there are balanced funds which invest only half the amount in shares. By the way, the bonus amount of an endowment policy is based on the insurance company’s profit. What if the company made a loss?

Thus there are better ways to invest than taking an endowment policy. Though I haven’t told you how to plan your investment or what to take, I hope that this post would have helped you to think a bit before going for an endowment policy.

Back Slash: An insurance agent gets commission for every premium you pay. For an endowment policy, you will pay premium for longer time periods; 25 years may be, possibly the reason why he may persuade you to go for an endowment policy and may not tell you about the more essential, term-insurance policies.