Life is a lemon and I want my money back….

The most popular insurance product in India seems to be Endowment Policy!!

Why? Because we like to get our money back!!!

When someone is taken for a ride it is easy to blame the victim, but it is often the defrauder who exploits the good nature/vulnerabilities of the victim.

Instead of reading a long diatribe about the insurance companies selling unsuitable products, lets look at an example.

Scenario 1

  • If you are a 30 year old and buy insurance worth 1 crore (endowment plan) that covers you for next 35 years.
  • You will be paying 2.5 lakhs a year for the next 35 years. You will be guaranteed a 1 crore at the end of the policy period and you could get upto 2.5 crores if the funds does well.
  • If you survive 35 years, you will have a maximum of 2.5 crores. If not, your family gets paid 1 crore and a bit of bonus.

Scenario 2

  • Let’s look at an alternative where, you buy a 1 crore Term Policy and invest the remaining funds.
  • Cost of purchasing a Term Insurance for Rs 1 crore would be about 27,000.  Lets round it up to 30,000.
  • Money left with you 2,50,000 – 30,000 = 2,20,000/-
  • If you invest the remaining 2.2 lakhs at 8% in a FD or long term bond you will have 3.8 cores.
  • If you survive 35 years, you will have 3.8 crores. If not, your family gets paid 1 crore and has money in the bank that is growing at 8% per year.

Scenarios 2.a

  • If you invest the 2.2 lakhs in an Equity Index fund paying 12% you will have 9.5 crores at the end of 35 years. We believe, for a 35 year horizon, Equity Index fund is the right investment option.

Scenario 2.b

  • If you are not very comfortable with Equity Index fund you can chose to put in 1.5 lakhs in long term bond and 70,000 in an Equity Index fund.
  • 1.5 lakhs for 35 years at 8% will be 2.5 crores (maximum amount guaranteed by Endowment policy)
  • 70,000 invested in Index fund assuming 12% return will be worth 3 crores at the end of 35 years.
  • You will have a net of 2.5 + 3 = 5.5 crores in 35 years.  And you can be sure that this option is better than endowment plan as you get the same return promised by endowment plan and the return on your Index fund will be your bonus.

If you are buying a new insurance, esp. endowment or unit linked products, pl. spend 20 minutes reviewing the policy using XIIR function in excel. If you are not familiar with XIRR function pl. use the following link. With XIRR, you are looking to see if the rate of return you get with the insurance product is better than the bank rate or even inflation rate. We can almost guarantee that this will not be good. If you are unhappy with the rate of return, we suggest you consider buying a term insurance and invest the remaining funds in a fixed deposit or an Index fund (depends on your situation). Pl follow this link to read more.

If you have already purchased an endowment plan, you may still want to review your XIIR and then plan your exit options. The trade-off here will be, when to stop paying for endowment and switch. For most part, we are sure you are better off closing your endowment plan right away, buying a term insurance and investing the remaining funds. Rarely, you may find that you are slightly better off paying off till the lock-in period and then switching to a term policy.

Pl remember: Endowment policy is a lemon – ask for your money back!


 IndusWealth:Making your money work for you

About Praveen Reddy

http://in.linkedin.com/in/praveenreddyinduswealth

5 Comments

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  1. Anonymous says:

    Interesting

  2. Anonymous says:

    What happens if a Unit Linked Insurance is one of the best run funds – post the course correction done a few yrs back on ULIPs – is this still not a good option?

    • Praveen Reddy, Principal Advisor, IndusWealth says:

      Insurance companies offer good insurance products but are poor at managing money. Insurance and Investments are two separate products, they are combined as many of us are not comfortable treating life insurance as an expense and are looking for some money back.

      For your ULIP investments, the benchmark you should be looking at is Index and not a bank rate of interest, as the risk taken by ULIP is higher. You can look at the risk reward article in IndusEdu Section.

      Unit linked plans – are taking exposure to the markets, almost all the ULIPS and Mutual funds fail to beat NIFTY over a 3 to 5 year period. This is true across the world, lot more research has been published in US ad UK.

      We suggest that you look at NIFTY returns in the same period as the Unit linked plan.
      If the ULIP has beaten the market over last 3 to 5 years (which is a very rare case), Pl review the performance annually, just to make sure that they continue to do so.
      If the NIFTY returns is more than 1% of the ULIP, Pl consider taking some action. A 1% difference in rate of return will translate to a significant amount – due to the compounding effect. (You may want to look at Power of compounding in IndusEdu section).

      Happy Investing….

      Praveen Reddy
      Principal Advisor
      IndusWealth

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