Dont Fall For The Endowment Pitch

A simple and less expensive combination of a term cover & PPF works better than complex endowment policies
Preeti Kulkarni

PLUS a change, plus cest la mme chose wrote the French writer Jean-Baptiste Alphonse Karr, way back in the January 1849 issue of the journal Les Gupes (The Wasps). When translated into English it means the more things change, the more they remain the same. Nowhere is this more true than for the Indian insurance industry. The industry which built its enormous size on the back of selling, or rather misselling, Unit Linked Insurance Plans (Ulips), found itself in a spot of bother when the agent commissions on Ulip were cut earlier this year. Of course, insurance agents got around the problem rather quickly and are going slow on selling the newer low-commission paying version of Ulips. Instead, they are now focusing on selling high commissionpaying endowment plans.

The New Sales Pitch:

Ulips, which were hailed by insurance agents as magic wands capable of giving triple benefits of insurance, investment and tax-saving, are suddenly being dubbed volatile as they are market-linked. The value of your investments in Ulips can yoyo, so it is better to invest in endowment plans, goes the new sales pitch. Endowment plans (along with traditional pension plans), can serve policyholders interests better as they offer stable returns in the form of bonuses declared by the insurance company every year in addition to providing a life cover. These are the things which insurance agents are now communicating to prospective customers. Recently, I came across a case where an agent convinced a couple to liquidate their investment in a Ulip and switch to an endowment plan instead, says financial writer Uday Kulkarni. The bait was, of course, the assured returns they supposedly offer. While people often talk about the high-commission structure of Ulips, there is little focus on endowment plans where the charges are simply not revealed. If the commissions are in the range of 810% in case of Ulips, in endowment plans it could be as high as 30-40% in the first year, he adds. So now you know where the new found love of agents for endowment plans comes from. Whats more, with the insurance regulator categorically ruling out any measures to cap charges on traditional policies, it seems that the new form of misselling is here to stay. You, on your part, can stonewall this old-wine-in-a-new-bottle strategy, by asking the right questions and taking a decision on what suits your needs the best on the basis of your knowledge.

Behind The Veil:

By design, endowment policies are debt-heavy which means that they invest only in approved debt or government securities, and not in equities. Consequently, they generate low returns. Most endowment policies yield returns of around 5% per annum which, at best, could go up to 6% in some cases, particularly LIC policies, says certified financial

planner (CFP) Pankaj Mathpal. Or lets put it this way, even if the actual returns earned were to cross these figures, you will never know. Why, you may ask. The answer to that question is that under endowment plans, the insurance company is under no obligation to reveal where your money is being invested or what portion of your money is being invested. The brochures of these plans do not specify the charges that will be deducted from the premium paid before investing the balance. Of course, agents are putting this lack of transparency to good use by telling the prospective customers that unlike Ulips these plans have no charges and all their money gets invested. This is not correct. Endowment plans have higher charges than Ulips. Its just that the insurance company is not obliged to give an exact break-up (which Ulips have to spell out). The products, therefore, lack transparency offered by Ulips, which, despite their muchmaligned status, at least gave a clear indication of how your money is being used.

High Charges, Low Returns:

In an endowment policy, the policyholder is insured for a certain amount. This amount is referred to as the sum assured. The insurance company also announces a bonus, which is a certain percentage of the sum assured, from time to time. When the policy matures the accumulated bonus as well as the sum assured is paid out. Before Ulips became popular, agents used the concept of a bonus to mis-sell endowment plans. Lets assume that a 25-year policy with a sum assured of 10 lakh entails an annual premium of 38,000-40,000. If the company paid a bonus of 50,000 (or 5% of 10 lakh), the agents would go to town saying that the bonus of 50,000 was more than the premium of 40,000. Of course, what they never revealed was that the bonus did not compound. What this means is that if an insurance company declares a bonus of 5%, or 50,000, the amount will stay the same till the 25th year when the policy matures. This explains the low returns that you should expect from investing in endowment plans. Besides, contrary to what the agents promise, the bonuses on endowment plans are not guaranteed. This misselling trick is also gradually making a comeback. Not applying the principle of compounding is primarily why at maturity, the returns are unable to break the 5-6% barrier which is incapable of beating inflation. Also, there are better (read: more remunerative and liquid) avenues at your disposal. When someone is looking to invest for a long period of time, debt instruments (where endowment policies invest) are not the ideal vehicles. In that context, I would say endowment plans are not advisable, says Suresh Sadagopan, CFP, Ladder7 Financial Services. Instead, you could look at investing the money in a diversified equity fund for the long term. Also, those not comfortable with equity can try a combination of a public provident fund (PPF) and a term plan. As can be seen from the accompanying table, it is indeed a better bet with an individual making 26.84 lakh at maturity in comparison to 22.5 lakh in case of an endowment plan. Moreover, in case of the term and PPF combination, if the insured passes away, his nominee also gets 10 lakh from the term insurance policy. So, the next time your agent tries to entice you into buying an endowment policy by dangling the carrot of yearly bonus that exceeds the annual premium, remember that at the end of the day, its the accumulated corpus that matters. What a complex endowment product can do, a simple term plan along with a large-cap equity mutual fund can do better.