Why Endowment Plans May Not Be a Good Investment Choice for You

Individuals buy such insurance policies with the aim of generating returns on their investments. Despite the apparent attractiveness of this approach, it is imperative to assess whether these insurance cum investment policies truly contribute to meeting your long-term investment goals and fulfilling your life insurance needs.

Let's first understand what endowment plans are.

An endowment plan serves as a life insurance policy that combines life coverage with the opportunity to regularly save over a specified duration, leading to a lump sum payout upon policy maturity. This maturity benefit can be utilised to meet diverse financial needs such as funding children's education, saving for retirement, purchasing a home or a car, and covering expenses related to children's weddings.

In addition to the maturity benefit, the endowment plan ensures that the beneficiary/nominee receives the full sum assured amount in the event of an unforeseen circumstance. Hence, the endowment plan can be characterised as an insurance scheme that facilitates savings and provides a lump sum payout upon maturity.

Key benefits of the endowment plan encompass ensuring the financial security of loved ones, eligibility for tax exemptions under sections 80C and 10D of the Income Tax Act, goal-oriented savings, and the option to avail a loan facility against the policy in case of emergencies.

Why are endowment plans so popular in India?

A considerable number of Indians hastily purchase insurance primarily for tax-saving purposes, often without a comprehensive understanding of the products. The insurance agent is usually someone familiar, such as a neighbour, friend, or relative, making it difficult to decline their request to get the policy. Consequently, individuals find themselves buying endowment policies without much deliberation.

Furthermore, there is still not enough awareness about life insurance in India. Many individuals view insurance as a futile expenditure, leading them to believe investing in a product that offers some return is more beneficial. Much like their oversight of the impact of inflation, they also overlook the subpar returns associated with these products.

It is observed that most insurance agents use the same sales pitch that endowment plans offer stable returns for a long period along with insurance coverage. They often compare endowment plans with bank fixed deposits that do not offer insurance coverage. This makes the potential buyer believe that an endowment plan is the greatest investment tool that offers the best of both worlds.

Now, you may wonder why an insurance agent would only pitch endowment policies and not term plans that are more beneficial to the policyholder. Well, agents aggressively promote these policies due to the attractive commissions associated with them.

Why endowment plans might not be a good investment choice for you?

First things first, let's talk about the insurance component of the endowment plan. You might assume that opting for a traditional life insurance plan ensures comprehensive coverage for your life, but that's a misconception.

In reality, endowment plans fail to adequately address the need for extensive life coverage. For instance, when you pay a premium of Rs 1 lakh per annum for 10 years for an endowment plan of 20 years term, it provides a life cover of roughly Rs 12 lakhs. Clearly, such a modest sum would not provide sufficient financial support for an individual's family in the event of the breadwinner's demise. Conversely, by directing these funds toward a term plan, one could easily secure a death benefit ranging from 1 to 1.5 Crores for a ¼ premium amount.

Now, let's move to the investment component of the endowment plans. You may know that ULIP plans may generate attractive returns in the long term as the funds are further invested in both, debt and equities. However, they generally carry higher charges, reducing the overall returns in the long term. In the case of endowment plans, the underlying assets can only be approved debt and government securities. The insurance company cannot invest the pooled sum into equities.

The underlying asset of the endowment plans, i.e. approved debt and government securities, typically generate 5% to 7% returns per annum. This is why returns generated by endowment plans are often lower than those generated by equity or equity mutual funds.

The insurance companies highlight the "fixed returns" and "bonus" components to promote endowment plans. They announce a bonus on the sum assured every year, which may sound hefty to the policyholders. However, this bonus is not paid to the policyholders immediately. It is accrued and only paid out when the policy reaches maturity, i.e. roughly after 15 to 20 years!

Similarly, single premium insurance policies are promoted as "double your investment in 15 years" or "triple your investment in 20 years". While this sounds alluring, if you calculate the exact returns, they are merely 6% to 7% p.a. These returns are often lower compared to the returns received from a bank fixed deposit of the same tenure and fail to beat the inflation.

Let's take the example of my friend Sahil, who opted for an endowment plan at 25. Presently, at the age of 35, he is still paying an annual premium of Rs 50,000 for a sum assured (coverage) of Rs 10 lakhs. The policy is set to mature in another 10 years at 45, a decade from now. Despite the insurance company consistently declaring bonuses over the past decade, Sahil has yet to see these reflected in his bank account. According to the policy terms, he will only receive the accrued bonus at the time of maturity. This means that any bonus he has accrued remains dormant until the plan matures, yielding no compounded returns. In contrast, the insurance company benefits by investing the same bonus until the plan reaches maturity. The failure to consider the principle of compounding is a key reason why, upon maturity, the returns are limited to a range of 5-7%. This falls short, particularly for those with long-term investment horizons.

Even if the underlying assets generate better returns than this, you may never come to know about it, as it is not mandatory for the insurance companies to disclose what percentage or where your money is further invested. Moreover, the insurance companies are also not obligated to disclose the exact breakdown of charges.

Furthermore, endowment plans offer no provisions for partial withdrawal or the ability to manage one's asset allocation independently; the funds are directed according to the insurer's discretion. Additionally, the plan parameters are fixed at the policy's commencement, meaning you won't benefit if market conditions improve and bond prices rise - the insurer, however, stands to gain.

Endowment plans are highly inflexible in their structure. They generally do not allow premature withdrawal in the first few years of policy commencement. Even if some plans may offer some liquidity in the initial years, the surrender value you receive is much lower than what you had invested. These plans typically offer a substantial surrender value only around the tenth year of policy commencement.

These highly illiquid plans put individuals in a vicious cycle of continuously investing without the ability to recover, as the prospect of writing off an investment is generally undesirable.

Now, you may ask, but the endowment plan at least gives something in return in case of survival, unlike a term plan. So, isn't it a wise choice?

Let me tell you, insurance, at its core, serves as a tool for risk management. It was fundamentally created to shift the risk from the insured party to the insurance company, not to serve as an investment tool. For instance, purchasing health insurance or car insurance is not aimed at wealth accumulation but at ensuring reimbursement in the event of hospitalisation or car damage.

This same principle applies to life insurance. It is crucial to view a life insurance policy not as an investment tool, but as a means of protection. In the unfortunate event of any mishap, the policy provides a settlement to ensure that the dependents are financially supported, preserving their quality of life after the policyholder's demise. Therefore, the most prudent choice in insurance is a term plan.

It is advisable to maintain a clear distinction between insurance and investment. If you have financial dependents, prioritise getting term insurance with sufficient coverage. Allocate the remaining funds into carefully selected diversified equity mutual funds. However, for risk-averse people, it is recommended to adhere to a term plan combined with a reliable Public Provident Fund (PPF) and bank fixed deposits. This strategy is likely to yield superior returns compared to an endowment plan.

Suppose you are 35 and buy an HDFC Life Sanchay Fixed Maturity Plan with a 15-year term. The premium payment term is 10 years, and the annual premium is Rs 1 lakh. This plan offers a death benefit of Rs 10 lakh and a maturity benefit of Rs 16,86,400.

Instead, if you buy HDFC Life Click to Protect Super Term Plan with a suitable sum assured (death benefit) of Rs 1 Crore, you will have to pay the premium of only Rs 9,060 p.a.

You can invest the remaining amount in one or two well-performing equity mutual funds. Suppose you invest Rs 90,000 for 10 years in a mutual fund scheme that generates 12% returns on average and remains invested for 15 years. In this scenario, apart from covering yourself with life insurance of Rs 1 Crore, you also receive Rs 31.2 lakhs after 15 years.

So, even if you deduct the term plan premium cost of Rs 1.36 lakh for 15 years, you will still earn decent returns.

Have you already bought an endowment plan?

If you have already bought an endowment policy, you can cancel it within the free-look period of 15 days. The insurance company is obligated to repay you the entire premium amount if you cancel the policy within the free-look period.

If your free-look period is over and you are in the initial years of policy commencement, it is advisable to do the cost-benefit analysis by calculating the loss of surrendering the endowment policy and acquiring the new term plan.

To conclude:

Understand that insurance and investments are two separate concepts. Avoid intertwining insurance and investment, as doing so will likely result in suboptimal returns for both.

If you find yourself caught in unnecessary and unprofitable insurance policies, and if you aim to make sound financial decisions to preserve your hard-earned money, it is advisable to reach out to a SEBI-registered financial planner.

Disclaimer: "The securities quoted are for illustration only and are not recommendatory".

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.