Sunday, September 24, 2006

Why one should avoid traditional endowment plans

Just wanted to illustrate with this example why Term + PPF is better than LIC guaranteed return endowment policies (or) any traditional endowment policy from any company.

In the below example, I am comparing the returns from Komal Jeevan(which guarantees 7.5% per annum bonus) against term insurance plan(for insurance) and PPF(for investments). The plans are for a 30 year old male for a sum assured of Rs.5,00,000.

Komal Jeevan Plan
Sum Assured: Rs.500,000/-
Yearly Premium: Rs.37,177/-
Total Premium Paid in 18 years: Rs.6.69 Lakhs.
Returns by the end of 26 years: Rs.14.75 Lakhs.

Term + PPF:
Sum Assured: Rs.500,000/-
HDFC SL Term Insurance Yearly Premium: Rs.1,600/-
PPF Investment Yearly: Rs.35,577/-
Total Investment(PPF + Term Insurance): Rs.37,177/-
Total Premium Paid in 18 years: Rs.6.69 Lakhs.
Returns by the end of 26 years (8% PPF returns): Rs.26.63 Lakhs.
Percentage of investment that is used to pay term insurance: 4.3% per year.

Returns from Komal Jeevan which gives Rs.37,500 bonus per year is lot less than what you get back from PPF.The reason for this is quiet simple. Endowment Plans gives bonus based on the sum assured. Your returns each year is the same irrespective of your investment. In an endowment plan there is no compounding effect on your investment, interest. Hence the returns are very low. On the other hand, investments in PPF which is guaranteed by Government of India gives 8% returns compounded annualy. The power of compounding is immense, hence your returns are almost double than what you get from an endowment plan. Even if you invest in avenues which offer compund interest of 5%(like bank FDs, RDs), you will get back Rs.15.5 Lakhs at the end of 26 years.

Lesson 1 for an Investor: Power of Compounding
Compound Interest of 5% per annum will give higher returns than bonus of Rs.75 per thousand. Please donot be tricked by LIC agents who say 7.5% bonus has been declared for that year. Bonus is purely on sum assured and not on your investment. Only invest in avenues where your returns are compounded. Stay away from traditional endowment plans. These plans are the most beneficial to the insurance agent(in terms of commision received) but are not the best plans for the investor.

Lesson 2 for an Investor: Understand your charges properly
Insurance agents use the terms 80% charges on endowment plans is better than 100% charges on term insurance. But are you really paying 100% charges on term insurance. From the above example
100 % Charges for Term Insurance = Rs.1,600/-
80% charges on Endowment Plan = Rs.29,741/-
One is paying Rs.1600 charges in term insurance while paying Rs.29,741 as charges in endowment plan the first year. But how come insurance agents say paying Rs.1600(100% charges) is worse than paying Rs.29,741(80% charges). In reality, the actual percantages are different. The total percentage of your investment that you pay for term insurance charges is just 4.3%(Rs.1600 out of total investment of Rs.37,177). The insurance agents hide the overall picture. It is your duty,the duty of the investor to understand the overall picture of charges.

Lesson 3 for an Investor: It is your Money!
What ever you invest is your money so understand where you are putting your money. Donot rush into something because someone else said so. Donot buy LIC plan just because your father said it is the oldest insurance company, most profitable and hence will offer the best returns. Do your home work. Explore all possible avenues of investment. Understand the product where you want to invest. Understand the charges, returns and also RISKS. This is no Rocket Science. All you need is pure common sense to understand most of the products. It is your hard earned money. A rupee saved is a rupee earned.


Anonymous said...

Very Good Illustration to benifit average Investor.


sandeeparya said...

I like your articles, which explains in details while keeping the simplicity intact. Nice illustration.

I have a query. I am currently living in US. I do have my medical insurance. Life insurance -No.

Is it worth to purchase the ULIP or Term Insurance from Indian companies?

Next is Can i do like this that get medical coverage , etc from US companies and invest in India in Provident Fund on regular basis and also block some money as investment in ULIP?

I do not know much.

Well regarding Mutual Funds. I do not have much Idea and currently just looking for information to learn that.

What do you suggest..

Raj Gopal Vuppala said...

Regarding term insurance, I am not sure if you can start a term insurance policy with Indian companies with you being in US. We have to undergo medical tests for term insurance cover above Rs.10 Lakhs and I am not sure how this can be done in your case. I will need to get this clarified. Why don't you opt for term insurance from a US insurance company. If I am not mistaken, most employers in the US provide term insurance. I beleive one can opt upto 10 * Salary as the max term cover in US. You might want to speak with your HR.

Regarding ULIPs, a portion of the premium paid provides "Insurance Cover" and the balance portion is "Invested" in the fund of your choice. If you are going to take an adequate "Term Insurance" policy for insurance cover, then for investments you can choose MF's. You should be able to invest in Indian MF's directly from US. I would advise you to contact the NRI division of CitibanK, HDFC or ICICI. They will guide you how to invest in Indian MF's from US. One good resource online to learn about Indian MFs is

My advise to you
1) Take a term insurance policy with a US insurance company (this will take care of your insurance needs)
2) Start investing in Indian MF's from US using the SIP route. (this will take care of your investments).

Anonymous said...


If you have invested Rs 35577 in PPF@8% for 26 years, it would give you Rs 30,72,101.00. Source: Savings calculator

This can perhaps emphasize the impact of compounding!!!

Raj Gopal Vuppala said...

Dear Umesh,
In my calculations, I considered 18 premium paying years. This at 8% compound interest works out to be 26 lakhs odd after 26 years.

But you are right, if I consider 26 premium paying years, it works out to be 30 lakhs+ after 26 years.


Anonymous said...

Can I open a PPF account for my 10 year old son? What are the benefits for me in the long run?