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.
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.