Endowment/money-back policies: Inadequate insurance, low returns

Dev Ashish

Traditional insurance plans such as endowment and money-back policies continue to remain popular in India. But are they any good?

Before we answer that, let’s understand why those relatives and friendly insurance agents sell these plans so aggressively.

It’s because of the high commissions they get. Almost 30-35 per cent or at times, even more of the first year premium is earned as commissions by them.

So, it’s obvious why they would want you to buy it. And bigger the premium, the larger their commissions. It makes plain business sense for them to sell you these ineffective investment-cum-insurance products.

Now you know why the traditional plans are sold so aggressively.

But let’s not blame the agents alone. Buyers themselves need to beware. Right? Your money is your responsibility.

Buyer beware

Many buy these plans in a hurry and for the sole purpose of saving on taxes. They have no idea about what insurance is meant for and how much cover they should have. They do not understand these products at all.

Let’s forget the agents and focus on the product itself. Let’s understand why you should not buy these endowment/money-back plans.

It’s true that its one simple product which doubles up as investment as well as insurance. It’s convenient. But such bundled hybrid products offer sub-optimal returns and leave you underinsured. So this convenience comes at a cost, which is not just high commission paid to agents, but also low returns and poor insurance coverage.

Let’s compare the insurance aspect of these first.

The premium for a Rs 50 lakh coverage (35-year old male; 25-year policy tenure) offered by the popular endowment plans (LIC New Jeevan Anand) is Rs 2.33 lakh per annum. Now, if you compare this with a term plan, the premium is about Rs 7000-8000.

The difference, without doubt, is eye-popping.

And here are a few other aspects. First, people aren’t aware of what the right insurance cover is for them. Second, if they wish to buy a large cover (let’s say Rs 50 lakh), they see the high premiums of traditional plans and get disheartened. But, as they are so used to these traditional plans, they stick with them, though they take a smaller cover for an affordable premium. The result is that they remain underinsured. This is the reason why Rs 5-10 lakh covers are so popular with traditional plans even when people know that it would not be enough. They just don’t seem to understand why term plans are better!

Poor investment

A part of the premium of these traditional plans goes towards providing life coverage. And another chunk to agent commissions. As a result, the amount of premium that actually gets invested to generate returns is reduced.

The following illustration is given in LIC’s website.

It shows that a 30-year-old buying a traditional plan of Rs 1 lakh for 35 years will pay a premium of Rs 3165 per annum. The total premium paid over 35 years is Rs 1,10,775. And the maturity value of the policy is Rs 2.56 lakh, assuming investment return of 8 per cent p.a..

Now interestingly, if you instead invest the money in PPF (public provident fund) that gives around 8 per cent annual returns for 35 years (after extensions), then the final corpus would be in excess of Rs 5 lakh!

So, it clearly shows that LIC’s maturity value is lower (even with the same 8 per cent assumed returns) because the full amount does not get invested and is used to provide a small insurance cover to you and big commissions to their agents!

Thus, you end up with about 4-5 per cent returns.

So, what are the alternatives?

Let’s use the earlier example of Rs 50 lakh cover. You have two options.

– Buy a traditional insurance plan with Rs 50 lakh cover at Rs 2.33 lakh annual premium; or,

– Buy a term plan offering Rs 50 lakh cover for Rs 7000 premium and Invest Rs 1,50,000 in PPF and the remaining Rs 76,000 in equity funds. The total outgo is Rs 2.33 lakh per year (same as above)

What would happen if you survive 25 years?

–  The traditional Plan will provide Rs 1.17 Cr as maturity pay-out (assuming 5 per cent returns as explained earlier)

– The term Plan will give nothing on maturity/survival (Rs 0). PPF will give Rs 1.18 crore (assuming 8 per cent returns) and Equity funds will give Rs 82 lakh (assuming 10 per cent avg. returns). The total amount is Rs 2 crore.

The above simple example shows why avoiding traditional plans is a wise thing to do. And unless you are willing to pay a huge premium which may be unaffordable for most people, you will remain underinsured with endowment and money-back plans.