Ajit is 35 years old now. When he started working at the age of 25, his father’s insurance agent had suggested that he take a good endowment insurance policy, as it would help him save taxes, provide insurance and also save money for the future. Since it made sense, Ajit did so and subscribed to an endowment policy for a term of 20 years, an insurance cover of Rs. 5 lakhs and an annual premium commitment of Rs. 25,000/-.
Now, 10 years later Ajit is older, more experienced and has greater awareness and knowledge on financial products. On doing a rough calculation on the policy, he found out that the IRR (Internal rate of return) was just about 6 % p.a! This is the case with most endowment products which give similar or lesser returns. Let us see why, even after a long term of 20 years or more, endowment insurance policies fare so poorly when it comes to returns.
- Out of the premium collected by the insurer, a significant chunk goes towards insurance cover, and another portion towards administrative and other expenses. Only the balance is available for investment.
- The return generated by the policy depends on the annual bonus declared by the insurance company. This bonus is a specific percentage of the sum assured. The percentage/amount of this bonus is not guaranteed and may not be declared if some year is particularly bad for the company.
- Most important. These bonuses declared never multiply! In the case of Ajit’s policy, if a 4 % bonus i.e Rs. 20,000/- is declared in year 1, it would remain Rs. 20,000/- even on maturity at the end of year 20 and not compound. So, even assuming that the company declares a 5 % bonus year on year, Ajit will get just a sum of Rs. 10 Lakhs on maturity ( the sum assured of Rs 5 Lakhs + accrued bonus of Rs. 5 lakhs).
Such a rate of return will not even be able to beat the high levels of inflation in our country, let alone grow the investor’s money. Hence keep it simple – invest in the plain vanilla low premium term insurance policy for your insurance needs and invest the differential premium in good financial products to save for the future.