Insurance |

What is Endowment Insurance Policy & how does it work?

Endowment Insurance is one of the oldest & most popular forms of life insurance policies in the world. Most of the current age plans are reincarnation of endowment insurance policies with some tweaking/twisting/addition of certain features as per perceived market demand. There are several types of endowment policies still in vogue in western countries. Traditional endowment policies may be with/without profit with limited term premium payment or full term premium payment options. Nowadays mostly with-profit plans are popular.

What is Endowment Policy?

Let’s first check available definitions for endowment plan –

As per Dictionary, an endowment is an act of endowing (providing) with a permanent fund/source of income/ property to an institution or person.

As per Investopedia– An endowment is a financial asset, in the form of a donation made to a non-profit group, institution or individual consisting of investment funds or other property that may or may not have a stated purpose at the bequest of the donor.

Wikipedia says, Endowment policy is a life insurance contract designed to pay a lump sum after a specific term (on its ‘maturity’) or on death.

Read – Life Insurance Planning

How do endowment insurance policies work?

True to its meaning the endowment policies are sold on the premise that as & when a person buys a policy he creates an estate for him to be used in future or for his loved ones who will get financial support in case he is not there. One interesting point to be noted here is that, in spite of financial planners, Wealth Advisors, financial bloggers advising people not to buy insurance as a medium of investment, the sale of endowment policies are still on the rise. I think the single most important feature of endowment plan behind this contradictory behavior of consumers is its simplicity. For a marketing person it’s simple to make his sales team understand the features of the plan and from a consumer’s point of view it’s easy to understand what’s in it for him.

Let’s look into a typical sales pitch for an endowment insurance policy:-

Most part of the discussion goes like this –You simply pay this much annually/half yearly/quarterly and you get such a huge sum after so many years. Here the consumer is anchored at two points- what he pays (nominal) and what he gets (huge) in definite visual numbers based on past bonus rates. Whereas in case of mutual funds first thing that occurs in prospects mind is “Mutual fund investments are subject to………Past performance….etc.” A mediocre/not-so-financially-literate investor immediately relates the maturity amount to his goal based on current estimation (mental calculation). Above all, unlike Term Insurance where security is meant for his dependents (for him, it’s only expense), here he can relate it to himself.
Second comes the Tax saving part at the time of investment and icing on the cake is Tax free maturity.
Last comes the topic of financial security to dependents in case of death of the insured. All in one solution for emotional issues like, funding child education/child marriage, retirement kitty etc. plays a major role in decision making and by that time actual need of insurance and rate of return becomes secondary.

Must Read – Life Insurance is Not an Investment

Endowment Insurance vs Term Insurance

There is no denying the fact that Term Insurance is the cheapest & purest form of insurance and there are better products available for investment purpose, if you can distinguish between two different needs. Even the combination of Term insurance and PPF for a conservative investor can yield better results than bundled products like endowment policies, which work mostly in favour of insurance companies.

Is it Good to Buy Endowment Plan?

There are two vital aspects to be given due importance while buying an endowment Assurance policy:-

Premium– This is the amount you pay on regular intervals for a defined period (premium paying term) to keep the policy in force. Premium is lesser for younger age, whereas Maturity/Death benefits depend on sum assured. It means you have to pay more for same benefit at higher age resulting in lower rate of returns. The amount paid as premium is invested by the insurance company after deducting insurance costs and administrative costs. As per recent IRDA guidelines minimum 50% of investible surplus has to be invested in Central & State Govt. securities and rest in approved securities based on stringent norms for traditional plans. For ULIP’s as per type of fundchosen by insured or stated objective of the policy (here also norms for selecting securities is written specifically).That’s the reason returns from traditional endowment policies cannot be higher than average Bank rate of the intervening years. You also need to be sure that you would be able to pay the premium till specified term to avail the full benefits (insurance coverage or maturity benefit) of the policy. Premium paid for Add on covers/riders are not taken into consideration to arrive at Maturity Value or Surrender Value. People are sometime lured to buy insurance in the name of child for availing low premium rates but there are three major flaws in this hypothesis.

You need to add premium waiver benefit rider to safeguard the interest of the minor child which increases the total premium outgo.
Child becomes absolute owner of the policy money after attaining majority.(You lose control of the money, and in some cases people are found to regret the decision in the twilight years of their life)
Child policy cannot be assigned till the child is minor to secure loans in case of emergency.

Sum Assured– This amount determines the Death/Maturity benefit. In some policies Death sum assured and maturity sum assured is different. Death sum assured is the amount payable to nominee in case of death of the insured during the term of the policy which should be in force at the time of death. Bonus declared for the completed years also gets added to the death sum assured. In case of Maturity claim, Maturity Sum assured and bonus is paid. Sometimes companies also give loyalty additions but that’s not guaranteed. Please verify the Bonus rates from the website of the insurance company and don’t fall prey to the misguiding terms like “better rate of return on investments”, “increasing Bonus rates in future” etc. Please note that Bonus rates may increase or decrease depending on the prevailing interest rate scenario.

It would do well to understand the pros and cons before signing on for an endowment policy.

Read – Best LIC policy for High Returns

Hope this post clarifies all your doubts about what is endowment plan & how it works. If you have any questions regarding endowment insurance policy – add that in the comment section.

Risk Analysis & Insurance Planning: Foundation of Financial Plan

We must always consider insurance as the foundation of our Financial Plan. Insurance protects a household from unforeseen risks. Risk includes liability, damage of property/asset, death, disability, health and long-term illness etc. Some risks may be self-insurable and the rest are required to share with insurer by paying premium.

Justice is the insurance which we have on our lives and property. Obedience is the premium which we pay for it. – William Penn

What’s Risk?

During our day-to-day activities we’re exposed to loss (perils). The primary objective of insurance is financial protection (not emotional protection) to disastrous families due to death, illness, accident or loss of property.

Risk is the possible outcome of loss or no loss. We can define it either as “Pure Risk” or “Speculative Risk”.

In Pure Risk, the outcome may be loss or no loss. Pure Risk refers to losses due to death, accident, fire etc. Pure Risk is insurable.

On the other hand Speculative Risk is not insurable. Investment in shares means that there is a chance of gain or loss. You knowingly take risk and the outcome is either you’ll gain or lose.

Risk Analysis

Since insurance is complex. Risk Analysis is a process which defines and analyzes the nature, quantum & frequency of risk. It may be caused by nature, individuals, business and governmental agencies. Once the policy is in force, regular review & analysis is must. You may have to increase, decrease or terminate insurance coverage. An insurance review is a process that can go long way to protect you and your assets from unforeseen contingencies.

Once the risk is identified a Financial Planner tries to evaluate risk i.e. severity of loss & probability of loss.

Risk = Severity of injury or loss*Probability or frequency

Severity means the extent of possible loss, i.e. the amount of loss may be caused by an event. Severity of loss may be:

Slight
Moderate
Serious
Very serious

Severity helps you to anticipate the value of the loss due to loss of one arm, death, damage of property, etc.

In case of life, a Financial Planner considers the liability, responsibility, replacement value of income, inflation, tax etc.

Secondly, in case of property, a Financial Planner considers the market value or replacement value of the asset.

Priority of concern to a planner: High Frequency & High Severity & he also considers Low Frequency & Low Severity, which may be low significant. Again some risks are insurable and some aren’t. Then question of Risk Management arises.

Risk Management

This is a strategy to handle risks and reducing the severity of losses for accident or unanticipated losses.

Risk Management process analyze the following:

Objectives of insurance
Risk Identification
Evaluation of Risk
Selection of appropriate risk management & techniques
Implementation of risk management techniques &
Review of risk management techniques with corrective actions

The next step is handling of risk:

Risk avoidance
Loss control
Risk retention &
Transfer of Risk

Risk Avoidance:

It means to eliminate the possibility of risk either by hazard prevention or not doing any activities which may spawn risk. E.g. you may not drive or avail a car to avoid traffic accident or not investing into equities to prevent loss.

Loss Control:

As loss is the effect of a cause. An insured can reduce or control loss by identifying the factors that causes the loss and eliminate the factors. E.g. drive carefully in a thickly populated area. While drive the car not to consume alcohol.

Risk Retention:

While the asset, life or liability is not insurable, risk retention is one of the techniques of risk management. Reasons for risk retention:

Non-insurable or insurance is not available.
Insurance is too costly.
It’s better to retain risk for cost effectiveness.
Risk retention the only way where risks with high frequency but low severity.

Risk Transfer

Transferring of risk is sharing your risk with insurer (insurance co.). You may pay premium and transfer your risk to insurer. In illustration 1 & 2 I’ve mentioned how insurance started. By paying premium an insured can transfer the huge possible losses to insurer.

Insurance company assumes the risk on the basis of LAW OF LARGE NUMBERS by which the company estimates the amount of loss somehow accurately. The law of large number relates to probability, i.e. statistical concept. The morbidity or mortality rates depend on probability of loss.

What’s Insurance Planning?

What’s your perception about insurance? Still concept of insurance is nascent idea and most people neglect to assess risk and risk planning due to ignorance.

Both Contingency Planning and Insurance Planning are foundation of Financial Planning.

Insurance is a contract. While your insurance proposal is accepted it converts into policy i.e. a contract between you (insured) and insurance company (insurer). Insurance is financial protection or reimbursement against financial losses from insurer. If you overlook insurance, there may be substantial financial losses in case of any peril. It may be in personal life or any business or profession. Only insurance can indemnify financial losses against perils except life insurance as in case of life no one can define the value as property & liability. If you do not have proper insurance, your savings will get drained out or you may have to take costly loans. You may have to sell physical/ financial assets at once in distress.

According to D.S. Hamsell insurance is defined “as a social device providing financial compensation for the effects of misfortune, the payment being made from the accumulated contributions of all parties participating in the scheme.”

Nature of Insurance

Insurance is essentially a cooperative effort. A large number of persons agree to share the loss which a few of them actually incur. The basic objective is to share the loss among a large number of people. Thus it reduces the financial burden by sharing the loss.

Illustration 1

If there are 5,000 residential properties in a community (each of them valued @ Rs. 75, 00,000). It has been experienced that each year one house in a thousand is damaged by accidental fire & earthquake. The average financial loss is Rs. 75, 00,000 in each case. There is a possibility of 5 residential houses in the same community to be damaged by accidental fire & earthquake. But no one knows who’ll face the financial loss. In the community there’ll be a total loss of Rs. 3, 75, 00,000 in a year. The pooling of amount will be Rs. 7,500 p.a. (Rs.3, 75, 00,000/5000). Community gets peace of mind as the sense of insecurity faced by every member is removed by joint contribution.

Illustration 2

There are 20,000 people in a village each aged 45 and having similar expected longevity 70. From the experience, it has been observed that 5 people die out of thousand among this group. Therefore, 100 people will die in a year. But who’ll die? No one knows. If the average loss is Rs. 10, 00,000, there’ll be a total loss of Rs. 1000, 00,000 every year. The community decided not to live in uncertainty. They decided to share the risk among 20 thousand. The average yearly contribution is Rs. 5,000 (Rs. 1000,00,000/20,000). There’re two uncertain factors “who” & “when”. No one wants to live in uncertainty & to make them certain they start to pay Rs. 5,000 as premium. They realized that if they don’t pay the premium they’ve to bear the cost, i.e., Rs. one crore.

Pure Insurance premiums are relatively small than the losses. Those who’re insurable and have insurable interest can share the loss with insurance companies (insurer). This is the basis of Term Insurance policies.

Why Risk Analysis & Insurance Planning is so important?

A Financial Planner analyzes the followings:

Severity & frequency of a loss
Identify the available options
Try to select the best option
Prepare a plan
Implement the plan
Review & analyze the plan periodically

One has to balance between cost & effect. Risks may be dealt in many ways, i.e. by avoiding, reducing, sharing or retaining. There may be huge financial disaster if you neglect the same.

Birla Sunlife Recurring Savings plan review

When Birla Sunlife launched a product with name recurring savings plan, on the face of it looks like a different and new product. But when you check this out in detail you will find that it’s like any other Systematic Investment Plan. The main difference is that it is available with optional “Free Life insurance Cover”. Let’s look at this product in detail and find out its suitability in your profile.

Features of Birla Sunlife Recurring savings Plan

This Plan is all about Investing in 2 specified debt plans through SIP. The 2 specified plans are:

a) Birla Sunlife Medium Term Plan

b) Birla Sunlife Monthly Income Plan

In addition to this, one may opt for “Free life insurance cover” along with the Investment.

How much would be the “Free life Insurance cover” ?

Life insurance cover will depend on the monthly investment Installment and is offered under group insurance scheme. The coverage would be:

– Year 1 – 10 times of Monthly RSP Installment

– Year 2 – 50 times of Monthly RSP Installment

– Year 3 onwards – 100 times of Monthly RSP Instalment.

Subject to maximum of Rs 20 lakhs.

This insurance cover would cease if RSP discontinues within the first 3 years of Investment. But if RSP continues for at least 3 years and then discontinued then the Insurance cover would be equivalent to the value of units allotted at the start of each policy year subject to maximum of 100 times the monthly instalment.

How is it different from Century SIP?

Century sip is another product of Birla Sunlife mutual fund family where the same insurance covers are offered under some specific plans. RSP is no different from century sip. It is just that Recurring savings plan is only meant for the above mentioned 2 schemes but century SIP is eligible for other equity schemes too besides these 2 schemes.

This means that Century SIP in Birla Sunlife MIP and Birla Sunlife MTP is equal to RSP with Insurance covers.

Other Conditions to invest in Birla Sunlife Recurring savings Plan.

Age limit: Min 18 Years, Max 46 years.
Exit Load: 2% if exit in first year, 1% if exit in next 2 years and NIL after completion of 3 years.
Partial withdrawal: is allowed subject to exit load and insurance cover will be ceased if withdrawal happens before completion of RSP Tenure.

Performance record of the specified funds under Birla Sunlife recurring savings:

As the scheme is meant for monthly investments, so returns are only checked for SIP investments

Birla Sunlife Medium Term fund:

Fund Objective – The primary investment objective of the Scheme is to generate regular income through investments in debt & money market instruments in order to make regular dividend payments to unit holders. The Fund intends to optimise returns by keeping its portfolio duration between 1 year to 5 years. At anytime the maturity of the portfolio will be governed by the fund manager’s perception of the interest rate scenario prevailing in the economy.

Inception date: 26 march’2009

Returns on SIP of Rs 1000/- p.m. since inception till 26 Oct ’2012 – 9.31% p.a

Source: Valueresearchonline.com

Birla Sunlife MIP fund

Fund Objective – The scheme primarily seeks regular monthly income and also aims at capital growth with a predominant exposure to debt and money market instruments. The fund invests in a mix of high quality fixed income securities and a small portion in equities (a maximum of 15%).

Inception date: 18 Dec 2000

Returns on SIP of Rs 1000/- p.m. since inception till 18 Nov’2012 – 8.58% p.a

Source: Valueresearchonline.com

Should One Invest in Birla Sunlife Recurring savings?

One thing is very clear that the whole purpose of Birla for launching this product is to bring attention on two of its funds. Otherwise when these are already in the century SIP scheme and also available for SIP in normal course, it does not make sense to start with a fresh product.

From an investor’s perspective, it depends on the purpose of Investment. I don’t advise mixing insurance with investments. So if the Insurance coverage is the purpose one should go with only pure term plan. If investment is the purpose then again one should weigh the different options available and depending on the time horizon and risk profile one should select the funds. SIP in debt fund is very much comparable to bank recurring deposit. The tax efficiency, liquidity and returns offered in debt funds have always been very attractive from investment point. If you understand the working of insurance endowment plans and can do bit of maths to find out their return then you may also compare such plans with them too. But do keep in mind that Insurance plans come with some additional tax benefits. Read – What is Endowment Policy?

So the bottom line is that product is good, returns are good but still no different. One should look out for all other options too before selecting Birla Sunlife recurring savings.

The Insurance Dilemma

Rohit has been having this uneasy feeling that he is not properly insured. He already has an insurance of Rs.75 Lakhs and his company also offers another Rs.30 Lakhs. He had consulted his friend Parth, who informed him that he might be over insured considering that Rohit is a bachelor and has no dependants. Rohit’s parents live in Shimla and have their own home and pension.

But Rohit was not convinced, for he was earning about Rs.20 Lakhs pa and having a cover of just five times his gross income, seemed like too much of an under insurance to him. Parth has, infact, asked him as to why Rohit wants insurance. “If you were to pass away tomorrow, who will this money go to?”, Parth had asked. Rohit had replied that it will make his parents richer by over a crore. Parth immediately asked him why his parents required that money considering that they are financially independent. Rohit, ofcourse, understood that. But he had said,”I want to provide a cushion to my parents in case I’m not around”.

So, that was the problem. Rohit failed to see that he does not have to provide any further cushion than he had already provided, through the Rs.1 Crore cover that he has. He came to see me regarding this.

I understood the moment he narrated the whole thing that Parth had been right all along. Insurance is to cover the financial loss to the family in the event of the income earner passing away. Hence, insurance is primarily a security net to the dependants. As a corollary, if there were no dependants, there is no need for any insurance as there is no one who will suffer financially, if the insured is no more.

Rohit wanted to know then if the thumb rule of 8-10 times the gross income for the amount of insurance cover, does not apply to him. I told him that it does not apply and that he might actually be over insured at this point.

I suggested that what he should be actually looking for is accident insurance cover. He was all ears. I explained that accidental death is not the only thing it covers but also partial and total disability. Also, it covers Temporary Total Disability ( TTD ), when a person is unable to work for a period, due to the debilitating effects of the accident. In this period, an accident insurance policy with TTD cover would partially reimburse the insured for income lost. Policies typically offer 1% of the TTD Sum Assured per week as a benefit for upto 104 weeks. This could be a very useful addition in one’s insurance matrix. Rohit seemed convinced.

Critical illness insurance is another one could consider. Rohit has medical insurance of Rs.5 Lakhs and would cover any illness. However, the onset of a critical illness can potentially curtail the working life and can impact a person, financially. Hence, a critical illness insurance would prove useful as it gives a lumpsum payment on the onset of certain critical illnesses. This is a benefit policy and not a reimbursement for expenses incurred.

Rohit was excited to know about this. He wanted to know the definition of critical illnesses and which ones would be covered. I had to inform him that the catch actually lies there as critical illness policies covers only 8-12 diseases/ conditions whereas a person can suffer from any number of illnesses. It however covers the most common ones like cancer, heart attack, stroke etc. and is admittedly not a comprehensive list. However, it can still help to a limited extent. Rohit wanted to know to what extent he can take this insurance. Most companies offer between 5-10 Lakhs, though there are companies offering upto Rs.50 Lakhs. I had suggested that he consider about Rs.10 Lakhs.

Rohit wanted to know if he should take the accident and critical illness as riders. I advised that having stand-alone policies are better as they do offer better benefits as opposed to riders. Also, some riders terminate the policy too if they get activated.

Rohit seemed to be in thought. At least he was not harping any longer on life insurance. He seemed to have understood this. I left him to think it over carefully before acting.

Ignore Personal Accident Insurance At Your Own Peril

Life insurance covers the risk of death; health insurance covers the risk of sickness; where as personal accident insurance covers the risk associated with accidents. If the life assured is seriously injured in an accident and disabled either temporarily or permanently, he/she will not able to work and earn. To minimise the financial hardship of the life assured and his/her family members, the personal accident insurance provides the financial support. So personal accident insurance is very essential and Life insurance cover without personal accident cover is inadequate from risk management point of view.

The personal accident policy provides compensation in event of insured sustaining injuries solely and directly from an accident caused by violence, visible and external means, resulting in to death or disablement be it temporary or permanent.

Risks Covered:

Personal accident insurance policies are the domain of general insurance companies. They are issued for one year and renewed annually thereafter .But nowadays personal accident benefits are also being offered as riders by Life Insurance Companies and policies are issued for longer term like any other life insurance policies.

The sum assured is payable in the event of death due to accident. It also provides monetary payouts in case of disability-both temporary and permanent nature. Personal accident insurance policy is very important for a victim who suffers injury in the accident because it provides an alternative income, if the victim is unable to work.

Pricing:

1. Occupational Classification:

There are three types of risk classification of the insured person under personal accident insurance i.e normal risk, medium risk, and heavy risk persons. Higher premium is charged for higher risk category insured. The normal risk insured includes persons engaged in administrative functions such as doctors, lawyers, accountants, bankers and teachers etc. Heavy risk persons are those who are working in underground mines, circus, horse racing, mountaineering, skiing, ice skating, river rafting, hand gliding etc. Medium risk persons are those who are engaged in manual labours or supervision of manual labours excepting those falling under heavy risk category persons. They include builders, contractors, engineers engaged in supervision of construction activities, professional athletics and sportspersons.

2. Income Criteria

The income of the insured person is a major factor in determining the maximum sum assured under the policy. Since the monetary payouts in case of disability is aimed at providing an alternate source of income, the income generating capacity of the insured person is taken into account in validating the sum assured. Generally Sum assured is taken as 60- 100 times the monthly income.

3. Group Discount

Insurers provide group discounts when policies are issued to a group of persons with similar risk category. Even discounts are offered if policies are taken by the family members together.

Benefits:

Accidental Death

In case of accidental death, the nominee or legal heir will get the sum assured under the policy

Permanent Total Disablement (PTD)

If an insured person suffers from an accident which result in his/her Permanent Total Disability, the percentage of sum insured is paid as follows.

Loss of two limbs : 100% sum assured

Loss of one limb & eye : 100% sum assured

Complete loss of sight of both the eyes : 100% sum assured

Complete loss of speech and hearing : 100% sum assured

Permanent Partial Disablement (PPD)

If an insured person suffers from an accident which results in Permanent Partial Disablement and there is no reasonable medical hope of improvement i.e loss of an arm or a leg or an eye or hearing in an ear or any other disablement defined as PPD as per the policy in force, then a certain percentage of the sum assured is payable to the life assured. It ranges from 5% to 50%.

Temporary Total Disablement (TTD)

If the insured person suffers from an accident which causes a Temporary Disability and it completely prevent him/her from performing daily duties pertaining to his/her employment or occupation, then a weekly benefit (usually 1% of sum assured) to compensate the loss of income for a period not exceeding 100 weeks are payable to the life assured.

Benefits without payment of additional premium.

Certain benefits under personal accident insurance policy are paid without paying additional premium. Such benefits are reimbursement of expenses incurred on carriage of dead body, children’s education fund (maximum of 50 % of the sum assured each for 2 children) and cumulative bonus etc.

Benefits on payment of additional premium.

Certain benefits are covered by payment of additional premium such as reimbursement of medical expenses incurred for hospitalisation of the life assured, reimbursement of actual expenses incurred in purchasing blood through a hospital or blood bank, transportation of family members from the accident site to the hospital, cost of imported medicines and modification of resident vehicle etc.

Exclusions

The benefits under the personal accident policies does not cover
death, injury or disablement of insured person arising out of Sickness, intentional self-injury, suicide or attempted suicide, acts under the influence of intoxicating liquor or drugs, arising or resulting from the Insured committing any breach of the law with criminal intent, childbirth or pregnancy or in consequence thereof, war, enemy action, rebellion etc, nuclear accidents, change of occupation etc.

Conclusion

Personal accident policy premiums are much lower in comparison to the term life insurance or health insurance premiums. Further in view of the misery and financial hardship of the surviving insured after the accident, taking a personal accident cover is a necessity and should take precedence over life and health insurance cover.

Tag: Insurance