Problem with Endowment plans

In my earlier posts on traditional life insurance plans, I have tried to make simple excel models to demonstrate that traditional life insurance plans make for poor insurance and investment products. Such plans should be strictly avoided.

In this post, I will demonstrate why endowment insurance plans are bad without using any excel model.

In this post, when I use the term endowment plans, I am referring to the traditional endowment life insurance plans.

1.  You may remain underinsured with endowment plans

This is a problem with all insurance plans that provide investment benefits too. This applies to both traditional life insurance plans and Unit Linked Insurance plans (ULIPs)

Premium payment ability may determine your life coverage. For instance, premium for New Jeevan Anand for a life cover of Rs 50 lacs (Male, 30 years, and 30 year tenor) is Rs 1.77 lacs while premium for Rs 10 lacs cover is Rs. 35,591.

It is quite possible that you may not be able to shell out Rs 1.77 lacs as annual premium for Rs 50 lacs cover.

What do you do?

You settle for a life cover of Rs 10 lacs.

Purchasing life insurance is not shopping for grocery or shopping for clothes.  If you think a variety of apple at Rs 200 per kg is too expensive, you may purchase an apple variant which cost say Rs 140 per kg. It won’t impact you much in terms of nutrition and health.

However, life insurance is different. Just because you cannot afford a life cover of Rs 50 lacs, it does not mean your life insurance requirement is any lower.

You can purchase a life cover of Rs 10 lacs when the requirement was for Rs 50 lacs cover. Nobody will stop you.

But have you ever thought how your family will manage financially if something were to happen to you?

Perhaps not. High time you start thinking in that direction.

Build a good insurance portfolio is as important as building an investment portfolio.

If you fall short of the desired investment corpus, you may still figure out a way to manage since you are still around. However, in your absence, you family may not be able to do so.

2. Focus on the timing of bonus too

Let’s consider the example of LIC New Jeevan Anand.

Under participating traditional plans, bonuses are announced every year.

These annual bonuses make for an excellent sales pitch. The sales pitch goes like this.

You have to pay annual premium of Rs 35,593. In return, you will get annual bonus of Rs 40,000 (Rs 40 per thousand of Sum Assured) every year. Hence, effectively you are not paying any premium (or a low net premium). In addition, you are getting a life cover of Rs 10 lacs and a very significant amount at maturity.

Who can say No to such a brilliant plan?

However, during the sales pitch, the timing of the bonus is conveniently ignored.

Even though a bonus of Rs 40,000 was announced for your policy, you will not get this amount right away. You will get this only at the time of maturity of the policy.

It is not difficult to see Rs 40,000 today is not same as Rs 40,000 20 years later. Inflation will reduce the purchasing power of Rs 40,000 over 20 years. At inflation of 8% p.a., Rs 8,581 today will have the same purchasing power as Rs 40,000 20 years later.

For policy term of 25 years, the bonus announced after first year is given to you only 24 years later. Bonus announced after 10th year is given to you 15 years later.

In contrast, the annual premium has to be paid every year (and not at maturity). Hence, the adjustment of annual premium with the announced bonus is not the correct approach.

Moreover, the bonus of Rs 40,000 does not return any return till maturity.

3. Endowment plans provide poor returns

You get returns in the range of 4-6% p.a.  In a way, you get guaranteed poor returns with endowment plans.

You will be much better off purchasing a term plan and investing in PPF or mutual funds.

Must Read: Say No to Traditional Plans

4. Endowment plans have high exit cost

There might be unforeseen scenarios where you might have to exit your investment to fund an emergency. Alternatively, you might realize later that you made a wrong decision by investing in an endowment plan.

However, the exit penalty in endowment plans is very high.

In the first few years, you get hardly anything back.

Even after that, if you exit, you will get only a small portion of the premiums paid till the date of exit (surrender).

Hence, forget about earning good returns, you end up losing a part of premiums paid too.

The exit cost is so high that despite the poor returns that endowment plans offer, it may make sense to continue the plan (rather than surrender) if you have paid premium for a few years.

Must Read: Continue, Surrender or Paid-up

You can argue that the high exit costs ensure that policyholders stay in the policy and do not exit at the slightest temptation. I do not buy this argument.

ULIPs are insurance products too. ULIPs don’t have heavy surrender costs (as in traditional endowment plans). Please note I am not arguing that you must invest in ULIPs.

If you want investors to continue in your product, structure a good product. Do not create unreasonable exit barriers.

5. High commissions result in low returns

Even though the commissions are built into the price, IRDA and the insurance companies have shown no intent to rationalize the cost structure.

As much as 40-50% of the first year premium can go to the agents as commission.

This also explains the heavy surrender (exit) penalty.

Since the commissions for the initial years are quite high, the insurance company gets to keep a limited portion of your annual premium. If you surrender the plan, you can’t expect an insurance company to pay from its pockets because they have already paid the commission which can’t be clawed back.

They follow the easiest escape route. Penalize you.

When the commissions are very high, there is an incentive to mis-sell. The agents may be inclined to sell you plans that fetch them the best commissions (and not necessarily the plans that are the best for you).

Moreover, since the first year commissions are quite high, there is huge incentive for the agents to switch you to other plans or somehow convince you to reinvest maturity proceeds in a new plan.

Though I do not have any evidence, I have read at a few places that agents create a wrong impression that you will not get maturity proceeds unless you purchase another endowment plan from them.

So, the agents play on your fear and make money out of it.

6. Endowment plans are opaque

It is like a black-box.  I don’t know) what mechanism the insurance company uses to arrive at annual bonus amount.  You pay a premium. A number pops out at the end of the year.

Endowment plans are so opaque that even Government is not sure how to tax the premium amount. You pay 15% service tax on premium of term insurance plans. In case of endowment, everything is quite jumbled up. Hence, Government charges 1/4th the service tax rate (3.75%) in the first year and 1.75% in the subsequent years.

Who is at fault? IRDA, Insurance Companies or the Insurance Agents?

I would blame IRDA and the Insurance companies more. Insurance agents can only sell the products that are structured by the insurance companies. Of course, there are crooks everywhere.

If IRDA can rationalize cost structure of ULIPs, it can do the same with traditional plans. For the reasons known only to IRDA, they have chosen not to do this.

This has been done under the garb that insurance remains a push product and the distribution needs to be incentivized.

Well, ULIP is an insurance product too but the intermediary commissions are so high. Why different rules for the two types of insurance plans? ULIPs are far superior products to traditional plans.

Perhaps, IRDA does not want to take LIC head on.

By the way, LIC is not the only insurance company selling endowment plans or traditional life insurance plans. All private life insurers such as ICICI Prudential and HDFC Life sell such plans and those plans are equally bad. But yes, LIC is a behemoth.

LIC remains a cash cow for the Government and a source of easy money for meeting their divestment targets etc. The Government may not want to change the equation. Hence, many forces are at play that keep traditional plans safe from regulatory ire.

What should you do?

Simple.  Do not purchase any endowment insurance plans.

Separate your insurance and investment needs.

Stick to term insurance plan to meet your life insurance requirement. Choose investment products such as PPF and mutual funds for your investment needs.

Additional Read

  1. LIC New Jeevan Anand
  2. LIC New Money Back Plan-25 years
  3. LIC Children’s Money Back Plan
  4. LIC Jeevan Tarun
  5. LIC New Endowment Plan
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Deepesh Raghaw

Deepesh is a SEBI Registered Investment Adviser and an alumnus of IIM Lucknow. Deepesh provides customized Financial Planning and Investment solutions to his clients. Deepesh is passionate about personal finance and contributes regularly to leading Business Newspapers. Deepesh appears regularly on personal finance shows on Business Television.

16 Responses to Problem with Endowment plans

  1. Sagar says:

    Hello sir u r doing nice job regarding finance,I always recommend ur blog to my friends

  2. Abhik says:

    Hello sir, I’ll be really thankful if you could help
    I have 6 policies of LIC jeevan Anand in my father’s name with date of commencement 28-11-2006 and maturity duration of 16,17,18,19,20,21 years respectively for each policy, sum assured 1lakh each . I have paid premiums till last year. What if I stopped paying further premium’s, what will be the consequence and how much money will I get back at end of each policy term?

    • Deepesh Raghaw says:

      Dear Abhik,
      Do not surrender the plans. You have already paid premium for almost half the policy term.
      It is better to continue.
      For surrender value, you can talk to your agent or visit the nearest LIC branch. You will get the exact answer.

  3. Abhik says:

    No I will not surrender.
    But is there a option, that ,if I stopped paying further premium’s, I will get all the bonus accumulated till 2015 nd 1lac sum assured? Something like that.

    • Abhik says:

      At the end of policy*

    • Deepesh Raghaw says:

      Yes, there is an option of making it paid up. In that case, you do not pay any further premium and the policy continues with reduced Sum Assured.
      However, unless you need funds for something else, do not make it paid up. Keep paying regular premiums.

  4. Abhik says:

    http://www.moneycontrol.com/investor-education/insurance/classroom/want-to-discontinue-your-life-insurance-policy-heres-help-911328.html?classic=true

    I read this on this link!

    “all the benefits accrued from five years will be kept as it is and given at the end of 20 years”

    What benefits are they talking about, bonuses nd sum assured?

  5. Bindu says:

    Hello Deepesh,

    You are doing a very good job in educating people like me financially.

    I was discussing how helpful your blog was with my family and colleagues.

    I made the mistake of buying traditional LIC plans and realized it after reading your blog.

    Please advise if I can make the below policies paid up. Thanks.

    Policy Term yearsStart Date Sum Assured
    1Endowment Insurance Policy 21 22-02-200675000
    2Jeevan Anand 16 28-09-2011100000
    3Jeevan Saral 21 28-09-2013250000
    4Jeevan Anand 16 27-11-2013100000

  6. Jai says:

    Dear Deepesh,

    Please explain me what is called “Paid up”. Im having a Jeevan anand old plan 149 with start date as 28-09-2013 , 21 yrs premium paying term. Shall i continue or not.

  7. Ajinkya says:

    Sir you are doing great work…… thanks a tone for that sir

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