Long Term Insurance Policies – Are they profitable?
Long term Insurance policies – Are they profitable? A popular question related to insurance, people want to know… As you know, Insurance Companies market different types of long term policies like Endowment plans, ULIPs, Term Assurance etc. But Endowment Assurance is the most popular one among them. Let us do an unbiased analysis and try to find an answer to this million dollar question.
Before going into the subject, it would be better to be familiar with certain terms connected to insurance.
Term Assurance Vs Endowment Assurance.
Term Assurance products offer a high amount of insurance at a low cost. Pure term assurances will not provide any return at the maturity time. Ideally, Term Assurance has to be the first insurance product in the initial years of career development. And the reason is that, during that period, income will be low but the need of insurance will be high.
Read More: Term Assurance policy – why do you need it?
On the other hand, Endowment products have the Term Assurance element as well as Savings element in it. Endowment Assurance products generally offer a maturity benefit, which includes Sum Assured and Accrued Bonuses.
When you search the web, you may come across many advises about discontinuing your existing endowment assurance plans and switching to a term assurance and investing in equity or mutual funds for the savings needs. Let us also have a detailed look at this school of thought.
Benefits Offered in an Endowment Assurance Plan
Even though an Endowment Assurance plan is considered as just another savings plan by many, it is definitely more than that.
Most important benefits of endowment assurance policies are listed here.
| Endowment Assurance Vs Term Assurance – Benefit Comparison | |||
|---|---|---|---|
| No: | Benefit | Endowment Assurance | Term Assurance |
| 1 | Investment Profits | Profit Shared in the form of Bonus and Final Additional Bonus | Not available |
| 2 | Insurance Coverage (Increasing every Year) | Insurance Coverage = Sum Assured + Bonus accrued till date | Coverage not Increasing. (but High coverage at low cost) |
| 3 | Additional Accident Coverage | Additional Accident coverage equal to Sum Assured if DAB rider opted | No Additional Coverage available |
| 4 | Extended Permanent Disability Benefit | Disability benefit available with DAB Rider | Not available |
| 5 | Tax Benefit on premium under section 80C | Available | Available |
| 6 | Tax free Maturity benefit under Section 10(10D) | Available | Not applicable as there is no maturity benefit |
| 7 | Emergency fund provision through Policy Loan | Loan available after a premium payment of 3 years | No Loan Available |
| 8 | Critical Illness Rider | Available as Critical Illness Rider | Not available |
| 9 | Collateral Security for Loans | Surrender value of the policy is accepted for collateral securities | Cannot be used as Collateral Security |
| 10 | Liquidity through surrender (in emergency situations) | Surrender available from third year | Surrender not available |
This comparison is not intended to say that Endowment Assurance plans are far superior to the Term Assurance plans. The fact is that each one is different to the core.
In other words, Term Assurance is not a substitute for Endowment Assurance and can be considered complimentary, with there own strengths.
Investment Profit – Endowment Assurance Plans
Endowment assurance plans offer two types of bonuses.
- Simple Reversionary Bonus which is declared and added to the policy account every year.
- Final Addition Bonus which is provided as a one time benefit at the time of maturity.
One of the biggest mistakes of so-called investment Gurus in the Web is that they directly compare the returns of endowment plans with non-insurance products.
Endowment plan is a combination of savings and insurance and hence the insurance portion of the premium has to be separated from the savings portion to find out the returns offered by it.
Can you believe that an endowment plan can offer a return of around 7.93% per annum in the current economic scenario where bank fixed deposit rates hover around 6 %?
Read this article on How to calculate insurance investment returns to know more.
Bonus rates – Long Term vs Short Term
You may be knowing that Insurance products are designed in such a way that as term is higher, the offered bonus rates are also higher. But how much is the difference?
There is a significant change in the bonus rates as the term of the policy increases. Bonus rates of two popular Plans of LIC – New Endowment and New Jeevan Anand – is compared in the above chart. You can see that the Highest bonus rates are available for a term of 21 year and above plans.
The magic of Final Addition Bonus (FAB)
Final Addition Bonus (FAB) is a special type of bonus paid to endowment plans as a one time payment, at the time of maturity.
Change of Final Addition Bonus (FAB) is magical with an increase in term of the policy. If you go through the above info-gram, you can see that the variation is almost exponential.
For a higher term policy, the difference in benefits increases many folds with a simultaneous increase in Simple Reversionary Bonus rate and Final Additional Bonus rate.
As per the graph displayed above the maturity benefit of the long term, policies are considerably higher with increase in the term.
Interest Rate Offered By Insurance Plans – Long Term Vs Short Term
In order to find out the returns offered by insurance policies, we should calculate the Internal Rate of Returns (IRR) offered by them. I have taken the premium of 1 Crore Sum Assured plan for a 30-year-old person with various policy terms ranging from 12 to 35 years.
Term Assurance premium for corresponding ages was deducted to find out the returns of savings portion of the plan and IRR was calculated.
The result is against the common notion that Insurance policies provide low returns. The higher term policies offer a return up to 8.43% per annum.
Insurance Coverage – Long Term Vs Short Term
When we go for a long term endowment policy, it offers the following specific advantages in terms of insurance coverage.
- Insurance coverage obtained up to a higher age where insurance coverage is most needed.
- Higher the term the premium is considerably low and will help the policyholder to go for a higher Sum Assured.
- As the long term policies are taken at younger ages the premium will be comparatively low and the rate of returns offered on the premium will be higher.
Should I Surrender My Endowment plan and Invest in Mutual fund And Start A New Term Plan?
Many people ask this question to InsuranceFunda. This school of thought was invented by some Investment Gurus in the web, who claim to be financial planners. They neither knows the basics of Savings nor that of Insurance.
Savings linked insurance plans offers medium returns and are highly secured. On the other hand Mutual Funds have the potential to earn good returns with associated risk in it. Advising to invest all your savings in mutual fund or equity is against the principle of financial planning.
What you need is a balance between secured investments and risky investments.
Surrendering an endowment policy and taking a Term Assurance is not advisable. Reasons are given below.
- Surrendering an endowment policy can bring in a loss to your hard earned money
- You are losing valuable insurance coverage taken at a younger age with a lower premium.
- Endowment policies have some benefits which cannot be offered by term policies, such as, income tax benefits and liquidity.
- Grace period and claim concession period are always higher for the endowment plans and there is a higher chance to get a claim even if you miss the grace period.
- You cannot add Double Accident Benefit (DAB) and Critical Illness rider with a term plan.
Conclusion: The common notion of Insurance policies is that Long Term Endowment Assurance plans offer lower returns compared to other investment options. The profitability of an investment/savings plan has to be evaluated after considering all the benefits it offers. An Endowment Assurance plan offers a variety of benefits including increasing insurance coverage, Income tax benefits on premium paid, Tax-free maturity returns, and even serves as an emergency fund. The analysis shows that an endowment assurance plan can give an internal rate of return(IRR) even up to 8.43% if a longer a term has opted.
Read more:
How to calculate investment returns of insurance policies
Bonus Rates declared by LIC of India 2018
Death claim settlement ratio of Insurance companies 2019
picture courtesy
Anish L J is a ‘Financial Planner’ and member of Chartered Insurance Institute(CII), London and Insurance Institute of India. He is also a finance, insurance and software consultant. He thoroughly follows the developments in finance, insurance, and other related sectors.
Great analysis dear….
Thank You very much, dear Vasanth…