If you own endowment policies and have not evaluated them at the time of purchase, then do not shut your eyes, evaluate it now. Each additional payment of premium for the policy will make your decision to continue or surrender even more difficult.
To set the context, let me put a few lines on the history of financial and investment markets in India. In 1956, the Life Insurance sector was nationalised in India to form LIC. Over the next 4-5 decades, LIC was the sole company to offer insurance and investment products including Whole Life, Endowment and Annuity policies.
In those days, the financial market was not well developed and there were very few conservative guaranteed investment options (e.g. Bank FDs) available. This worked well for LIC as it was backed by the government hence people were assured of getting their investment and return back. With poor knowledge of investment options and limited alternatives, people lapped up endowment products as it was taking care of both insurance and investment need. The benefit illustration from LIC showed a big number over a longer period (hard to comprehend for an individual who is not comfortable with the time value of money concept) but never mentioned annual return on investment. The higher interest rate in those days made these numbers look even more attractive.
The economic liberalization in 1990 resulted in the establishment of SEBI to develop the Equity market and RBI to drive the development of the debt market. While the decade saw scams of Harshad Mehta and Ketan Parekh, the regulator learned from it and worked to make the market more robust. The launch of NSE and online trading democratized the equity market with a significant increase in people participation. SEBI and RBI put worked together to bring a range of investment products in the equity and debt market. The decade also saw the opening of the Insurance sector to private players and the launch of cost-effective e-Term (Term Life Insurance) policies which a customer can directly buy from Insurer, thereby reducing policy cost by bypassing insurance intermediaries (e.g. Agents).
In the 20th century, you would think that with more financial literacy, and better investment alternatives, people would evaluate endowment products before purchasing. But the high commission built-in product for intermediaries ensures that the product is pushed hard among the masses. In addition, when the intermediary is a relative, close friend and neighbour, people are giving common sense a pass.
So, what are the challenges with these products?
For illustration, let me quote an example of an Endowment and Whole Life Plan.
Endowment Policy Details:
- Age : 38 years
- Premium (Annual) : First Year – ₹ 3.13 lakhs, Second year onwards – ₹ 3.07 lakhs
- Sum Assured : ₹ 50 Lakhs
- Term : 20 years
- Premium Payment – Annual
- Insurance Coverage
- ₹ 64.75 lakhs to ₹ 1.11 crore with an annual increase to account for bonus (During first 20 years. From Age 39 to 58)
- ₹ 50 lakhs (From Age 59 to 100)
- Payment
- ₹ 98.5 lakhs (On completion of 20th year term)
- An additional payment of ₹ 17.2 lakhs post completion of 21st Year if you want to forgo ₹ 50 lakhs Insurance
- Tax Savings – ₹ 46,350
Observations:
- Investment Return
- Total Premium Payment (Over 20 years) : ₹ 61.57 lakhs
- Potential Return from LIC : ~₹ 1.21 Crore (Sum Assured – ₹ 50 lakhs, Bonus – ₹ 48.5 lakhs, ₹ 17.2 lakhs cash value in 21st Year against surrender of insurance from Age 59 to 100)
- The return from the investment is in the range of 5% to 6% and may not beat inflation in the long term which means you would be effectively losing the value of your investment. Even this return is subject to a non-guaranteed bonus payment, which is based on historical data and may come down in future.
- Liquidity
- You cannot surrender policy in first 3 years
- After 3rd Year, if you were to surrender your policy, you will get ₹ 2.67 lakhs against premium payment of ₹ 9.28 lakhs (Loss of ₹ 6.61 lakhs)
- If you have bought policy by mistake, the recourse is very difficult as the surrender may result in significant loss against the premium paid.
- Insurance
- The cost of Insurance is not explicitly mentioned in the policy document and cost-prohibitive. Insurance coverage is for the replacement of earning potential of a person. Paying a premium for Life Insurance beyond age 58 is unwarranted as earning capacity of a person diminishes significantly.
- Tax Savings
- You may not be able to take advantage of tax Savings of ₹ 46,350 as 80CC may be already covered for you.
To summarize, the endowment products are offered as one solution for all your financial needs i.e. Insurance and Investment but it does not serve either of the needs. The product is unnecessarily complicated and very difficult for people to understand. The illustration is socialized as though non-guaranteed benefits are guaranteed. The guaranteed portion is low (on average less than 50% of the sold commitment) and the bonus is conditional on the Insurer’s performance.
The bigger problem is the way these products are being marketed. High embedded non-transparent commission motivates the intermediaries to promote these products at any cost. These products are sold and not bought by the customer.
Listing few key issues for quick reference:
- Complex product. Very hard to understand.
- Mixes Insurance and investment.
- Loading of high commission motivates intermediaries to sell with lofty promises.
- Lack of honest illustration. Historical bonuses are considered for illustrations for the future.
- Inapplicable taxation is highlighted in terms of savings.
- Surrender is discouraged with a huge penalty.
- Requires long term commitment.
There could still be reasons for somebody to go for the endowment policy as they are uncomfortable generating returns higher than what is offered by endowment policies, but for the majority, their investment will be losing value over time.
In my recent working with clients, I have come across many who believe that their purchase of endowment policies was the sub-optimal decision and the only option for them now is to either exit the policy with substantial losses or continue with the existing policy with an understanding that the returns will be poor.
What shall you do?
My suggestion for individuals is to become educated and more vigilant. Ask the right questions and understand the pros and cons of the product offered. If you have to choose between guaranteed and non-guaranteed returns, prefer the former. Never believe in false promises, read and understand the policy document. What is written in black and white is what you will get.
Bottom-line, it is your money and only you are accountable for it. Take charge of it today for securing your financial future.
The writer is a SEBI Registered Adviser and Founder of FinMyn (https://finmyn.com). He provides Fee-Only Financial Planning and Investment Advisory services. If you want to know more about him, click on https://finmyn.com/about/.