Source: The Economic Times
Here is another innovation from the insurance stable - a rather traditional policy known as an endowment plan. The underlying theory is that unlike term insurance (wherein on survival, the insured gets nothing) the insured gets some amount back on surviving the insurance term. Something is better than nothing, you may argue. But is there anything called a free lunch? Let's look at some real numbers to get the right answer. Suppose you are 27-years old and have bought an endowment policy from one of the private insurers, with an annual premium of Rs 20,000 for an insurance cover (or sum assured ) of Rs 4,11,037. On death, this sum assured will go to your near and dear ones. So far, so good. Apart from this 'guaranteed' death benefit, the policy also provides a 'non guaranteed' component. So, are we getting something extra ? The insurer says that the death benefit will increase every year after the third year of taking the policy. To top that, the insurance company promises annual bonus. The big question is: at what rate will the cover and bonus increase? Insurance Regulatory and Development Authority's (IRDA) rules allow insurance companies to assume a minimum growth rate of 6% per annum and a maximum of 10% per annum for the purpose of illustrations given to prospective clients. If you examine the insurance company's calculations, as per the non-guaranteed growth rate of 6%, you will find that the death benefit grows from Rs 4,11,037 in the first three years to Rs 5,78,246 after 20 years. Though you don't get an annual bonus for the first two years, you get Rs 3,272 in the third year. If nothing happens to you, then at the end of 20 years, you will get Rs 5,94,464. So, in a nutshell, for the Rs 20,000 per annum you pay for 20 years, you get a minimum death benefit of Rs 4,11,037 from the time you take the policy. The latter figure grows to Rs 5,78,426 in 20 years. If you survive the 20 years, then you get Rs 5,94,464 at the end of 20 years. Now, let's look at things from another angle. How much money should you invest every year to earn an annual interest of 6%, so that you get Rs 5,94,464 after 20 years? Anyone with a basic knowledge of mathematics can arrive at the answer - Rs 15,300. This means that even if you put Rs 15,300 per annum in an investment instrument that yields 6%, you will still get a guaranteed sum of Rs 5,96,589 at the end of 20 years. But then, what about life cover, you may ask. Well, you are still left with Rs 4,700 from the annual premium amount in the example given above (Rs 20,000 minus Rs 15,300 = Rs 4,700). So, go ahead and buy yourself a term insurance of Rs 16,00,000 (which will cover you till you are 60) from the same insurance company! The moral of the story - buying a term policy is always the best policy.
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