Thursday, December 13, 2012

Read this before you buy one more Endowment or Money-Back Insurance Policy

The new year is just around the corner and the investment or should I say “Buy Insurance as an Investment” season is about to begin. Insurance salesmen will be selling Traditional Insurance policies like Endowment or Money-Back policies like hotcakes to people. I am not going to blame any of the insurance salesmen because they are just doing their job which is to sell insurance policies. The only thing we can do as smart investors is to be careful and buy only what we want.

Before we begin – Endowment and money-back policies are extremely safe and can provide guaranteed returns to people along with providing Insurance coverage. The purpose of this article is not to prevent you from buying these policies at all. If you read this article fully, you will be able to understand what I am trying to say…

What are Traditional Insurance Policies?

These are the most sold insurance policies in India. They collect premiums from people and give them decent Insurance coverage with guaranteed returns on maturity making them pretty attractive.

The most common type of Traditional Insurance policies are Endowment and Money-Back policies. If you go and talk to someone in their 50's or 60's (Someone who is of the age of our Father) about investments, the first investment they will suggest is an Endowment Policy by LIC. That is how popular these ultra-low risk investments are. However, the returns they offer are low too.

What Makes them Attractive?

The following are some of the key selling points for such insurance policies:
a. They provide a decent Insurance coverage
b. They can guarantee Capital Preservation
c. They provide guaranteed returns at maturity
d. They provide decent commissions to the salesmen to the agents who sells them

What Points do they fail to tell us?

The following are some key points that salesmen fail to tell us while selling these policies:
a. They have pretty low potential for returns
b. The premiums are invested only in debt instruments
c. The returns range only around 6%
d. If we consider Inflation, the net returns may come down from 6% as well

A Sample Calculation:

Let us say I purchase a policy where I pay a premium of Rs. 25,000/- every year now with a policy term of 20 years, below would be the calculation:

Premium paid in 20 years: Rs. 5 Lakhs
Guaranteed Sum Assured at Maturity: 5 lakhs
Insurance Coverage: 5 Lakhs
Expected Bonus: 4 Lakhs (Approx)
Net Amount at Maturity (If we manage to outlive the policy): 9 Lakhs

Net Rate of Returns: 5.5%

This above calculation does not hold good if the individual who took the policy meets with an untimely demise. His family is going to get the Guaranteed Sum Assured + Bonus irrespective of how many premiums the policy holder took. So, as insurance products they are ok but as investments they are not that attractive

If the debt market in India is extremely good over the next 20 years, the amount I get in the year 2032 may be around 9.5 or even 10 lakhs which may take the rate of returns to around 6 or 6.5% but it isn’t going to cross that.

Are you going to ask me why?

The reasons are:
a. A portion of your premium is paid to the salesmen as commission. So, not all your money is invested in debt products
b. The Insurance company takes all its operating profits & fees from the money you pay them
c. The average returns debt instruments can give is around 8-9% only
So, if we factor in the fees, profits, commission etc the net returns we may earn out of these policies will be only 5.5 to 6%

Some words before we wrap up:

As Insurance products Endowment or Moneyback policies are decent but they are currently sold as Investment products. An Investment is one that can give us returns that are at least as good as a bank fixed deposit but in this case it is at least 2% less than that. That is why I consider them as bad Investment ideas.

However, if you are someone who wants guaranteed returns even if it is low along with decent insurance coverage, these are very good products.

Disclaimer: The above article is purely the authors personal opinion. It is not personalized investment or insurance advise. I am pretty sure that Insurance agents will tend to disagree with my opinion above. If you feel any points mentioned above are incorrect, leave your comments below and we can have a useful discussion/

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