Endowment or money back policy – Simplified!

An endowment policy is a combination of insurance and investment: The life of the individual taking the policy is insured for a certain amount, which is usually a very small amount compared to actual requirement. The premium amount paid annually, goes towards Life cover and balance after deducting marketing & administrative expenses of the insurance company, is allocated & invested towards investment.

 An endowment policy may declare a bonus every year: The money that is invested generates a certain return every year. This return may be declared as a bonus. The bonus is typically generated as a certain proportion of sum assured or life cover as it is popularly known. The bonus declared is not payable immediately like a stock dividend or a mutual fund dividend which is payable immediately after it is declared.

 Since the bonus declared does not compound returns are low: Usually bonus declared, ranges between 3% to 6% (last 10 years data), for most of the Insurance companies. This is primarily because endowment policies largely invest in government securities and after taking into account the administrative & marketing expenses of the insurance companies, a greater bonus is highly unlikely. The bonus declared does not compound it, only accumulates and is payable only when the policy matures or in case the policy holder dies.

Example: (below is how a usual endowment policy looks like for an individual aged 25years)

Tenure: 30 years
Yearly premium: 31,000
Sum Assured: 10 Lacs
Maturity amount: 23.1 Lacs (this includes the sum insured + bonus accrued/ approx. amount) Data source: Insurance company website

Returns on above: Interest earned by the investment in Endowment policy = 5.4%

This return is very bad compared to any other investment product, where PPF on an average gives 8% to ELSS mutual fund giving 15% CAGR.

What one should do ideally?

One should buy Insurance & Investment products separately & not try to club it, like an endowment plan. Below examples will make you understand it better.

For Safe Investor
Term Insurance of 30 Lacs for 30yrs: 6k annual premium
Investment of 24k in PPF for 30yrs: 30 Lacs (this is assured returns, as its invested in govt. backed PPF, which gives approx. 8% post tax return, currently its 8.7%)
Amount invested = 30,000 per year for 30 years (same as Endowment policy)
Amount received on death: 30 Lacs + investments done in PPF
Amount received without Death: 30 Lacs (investments)

For Aggressive Investor (A person who can take more risk that the former one)

Term Insurance of 70 Lacs for 30yrs: 14,157
Investment of 17,843 (30000 – 14157) in ELSS for 30yrs assuming 15% CAGR: 92 Lacs
Amount received on death: 70 Lacs + investments done in ELSS
Amount received without Death: 92 Lacs (investments)

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