{"id":289,"date":"2018-11-15T18:18:03","date_gmt":"2018-11-15T12:48:03","guid":{"rendered":"https:\/\/srinivesh.in\/blog\/?p=289"},"modified":"2019-02-09T14:59:02","modified_gmt":"2019-02-09T09:29:02","slug":"avoid-endowment-plans-ppf-gives-better-returns","status":"publish","type":"post","link":"https:\/\/srinivesh.in\/blog\/avoid-endowment-plans-ppf-gives-better-returns\/","title":{"rendered":"Avoid Endowment Plans – PPF gives better returns"},"content":{"rendered":"Endowment plans are always popular with insurance companies and agents. Due to aggressive positioning, they also become the default choice for many individuals looking for life insurance. In this article, we compare this investment linked product with a separate investment product and show that it helps to not mix insurance and investment.<\/span>\n\n

Features of Endowment Plans<\/span><\/h2>\n\nOne formal definition of endowment plan is this:\u00a0\u00a0a type of insurance in which you pay a regular amount of money over a particular period of time, or until you die, after which the insurance company pays an amount of money. Endowment plans have been always popular with the insurance companies – by pitching the savings aspect, the sales people can avoid talking about grave matters like death.\n<\/span>\n\nThe savings aspect of the plan comes from the fact that these plans are eligible to share in the profits earned by the insurance company. The insurer invests the premium amount in a variety of avenues, earning returns. Based on the returns earned by it in the year, the insurance provider declares ‘bonus’ on the endowment plans. Many plans could also pay out a final, additional bonus.The bonus declared every year could be even higher than the premium amount. This is used as a selling point. However, this bonus is not compounded and is simply added to the corpus when it is paid out.<\/span>\n\nCompared to a simple term insurance, these policies have a higher premium; this is seen as a benefit by people focusing on tax deductions under Section 80(c). <\/span>\n\nThe biggest advantages of endowment plans could be these:\u00a0<\/span>\n\n
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  1. Disciplined saving<\/span><\/li>\n
  2. Payment at the time of maturity<\/span><\/li>\n
  3. Reasonably known rate of return<\/span><\/li>\n
  4. Possibility of using policy as loan collateral<\/span><\/li>\n<\/ol>\n\nThe disadvantages should actually outweigh the benefits, though many investors fail to see them.<\/span>\n\n
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    1. Low insurance cover for premium paid<\/span><\/li>\n
    2. Low surrender values are not typically disclosed<\/span><\/li>\n
    3. Returns are lower compared to market instruments<\/span><\/li>\n<\/ol>\n\nWe would look at the last point in detail and show that returns on a popular endowment plans are much lower than a reasonably assured return product like Public Provident Fund.\u00a0 One article that discusses endowment plans’ features is here.<\/a> Yes, these plans exist in many other countries too.<\/span>\n\n

      Review of popular Jeevan Labh plan<\/span><\/h2>\n\nJeevan Labh from LIC is described as a “Limited premium paying, non-linked, with-profits endowment plan which offers a combination of protection and savings.” A lot of insurance focused sites, blogs, etc.term this as one of the best endowment plans with high returns. A lot of the reviews of this plan, like other LIC plans, are featured by insurance websites. They obviously would claim that this is a great plan. More balanced reviews can be found in financial blogs. This article argues against the plan and asks if there is\u00a0 “LABH in Jeevan Labh”<\/a>\n<\/span>\n\nWith liberal assumptions on the bonus, the article calculates the annualized return to be between 6 and 7%. This is indeed a poor rate of return – even for a tax efficient instrument. However, insurance sellers have a habit of highlighting the future cash flows to give an impression that the endowment plan has high returns.<\/span>\n\nIn this article, we would use the illustration provided by LIC itself and compare these two approaches:<\/span>\n\n
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      1. Approach A – Jeevan Labh plan for Sum Assured of 2 lac, term of 25 years and PPT of 16 years<\/span><\/li>\n
      2. Approach B – A combination of a pure term plan for 25 years, and investment in a pure play financial product – Public Provident Fund<\/span><\/li>\n<\/ol>\n\n

        Jeevan Labh- Illustration<\/span><\/h2>\n\nThe details at\u00a0LIC illustration<\/a> provides a good amount of insight into the workings of the plan. A snapshot is provided below. Please note the two scenarios of return assumptions. The assumptions are for the entire life of the policy. For a large part of the policy term, the projected death benefit is above 2 lac even in the 4% return scenario.\u00a0 The benefit is of course higher in the 8% return scenario.\u00a0<\/span>\n\n \n\n\n
        \"Avoid<\/span>\n\n
        Jeevan Labh – Illustration by LIC<\/span><\/figcaption>\n\n<\/figure>\n\n<\/span>\n\n\n\nThe illustration image is a bit difficult to read. For comparison, please look at the various values (over the years) in the Variable column for Scenario 2.\u00a0 Assuming an 8% return, this amount is s 30,000 at the end of the 5th year, 60,000 at 10th year, and so on, going up to 1,70,000 at the end of the 25th year.\u00a0 The insurance agents would compare this with the total premium paid – about Rs 1,40,000 – and show how you are getting a lot of returns. We would show that this is not really the case.<\/span>\n\n\n<\/span>\n\n\n\n

        Alternative Approach – Illustration<\/span><\/h2>\n\n\n<\/span>\n\n\n\nFor this approach, we use these assumptions:<\/span>\n\n\n<\/span>\n\n\n\n