Investment + Insurance - Do you really need endowment policies?

Recently, I got a call from one of the insurance agents, giving me a plan which seemed out of the world. A little calculation proved how these insurance agents mis-sell their products, and how the top minds from the business schools do their best (and succeed) to sell these.

Below is the plan from the insurer (I would refrain from naming the insurer)

Plan A – Pay 60,000/- per annum for a policy with sum assured of 15 Lakh for 20 years, and get a life time pension (yes, till the time you die!!) of 60,000/- from 20^th year onwards. Consider that the person is a 30 Year old male.

This would seem too good to be true at the first sight, but devil lies in the details.

Let’s consider the (only) two possibilities-:

1. The person dies before the completion of the term, and insurer pays him the SA of 15 Lakh, and the policy is closed. 
2. The person pays all the premiums and insurer starts paying him the pension of 60000 per annum till the time he’s alive (Let’s assume the maximum age of 100 Years – So insurer pays him from 50 years age to 100 years age, i.e. for 50 years).

Excel provides a very powerful formula to calculate the returns when you are investing and getting money back at regular intervals. – IRR.

Below is the table that shows the IRR or – Rate of return for the policy.

Now, type the formula as =IRR(B2:B100). (Or, select all the values of amount paid).

The result you see will be 2.88%. That means, the overall rate of return if you are alive till 100 years of age, will only be about 3%. 

Age	Amount Paid (-ve)/ Received(+ve)
30	-60000
31	-60000
….	-60000
….	-60000
48	-60000
49	-60000
50	-60000
51	60000
52	60000
….	60000
….	60000
98	60000
99	60000
100	60000

Now, consider that the person goes via another route – that of separating insurance and investment, and create a similar plan for him.

Here’s how it looks like.

Plan B:

1. Term insurance for 50 Lakh with tenure of 30 Years. Premium for this person will be about 10000 per annum.
2. Recurring deposit for 20 years in a nationalized bank (Safest option assuming 8% interest rates) for the rest of the amount – 50000 (approx. 4200 per month).

Now, again there are only two possibilities -:

1. The person dies within the age of 30 years, he gets 50 Lakh (SA higher than LIC, and Cover period 10 years more than LIC), and has some amount in the RD option. 
2. The person completes the 20 years of recurring deposit.

If you see, the amount he gets back after 20 years of recurring is – 28,02,295. (Source - http://www.allbankingsolutions.com/Recurring-Deposit-Calculator-India.shtml)

Now, a simple calculation would show, that interest income on 28,02,295 assuming 8% interest (on PPF/ FD’s etc.) would yield about 2,24,180 per annum. 

So the person can withdraw a pension of 1,00,000 (much higher than the pension in plan A) and re-invest the remaining amount. This would mean, he gets a pension for the rest of his life, and his investment keeps on growing.

The above example assumed the safest options of investments (RD, FD, PPF’s etc.). If the person has a long term horizon (e.g. 10+ years), then a mixture of investment into Gold, Mutual Funds and Stocks etc. may fetch a return of more than 15%.

A huge number of LIC plans which are sold, fall in similar category, i.e. – A mixture of investment and insurance, which rather give a very low return. A classic example is the money back policy-:

http://www.licindia.in/periodic_moneyback_003_benefits.htm

If you try to calculate the IRR for the above policy, it'll be about 7% (best case) and 3% (worst case) as per the numbers provided on the page, which again, I think is not a good option.

In my opinion, any sort of a which mixes investment and insurance, can be broken down and a much better plan can be created using the above example.

A question may arise, as to why people would go to LIC if it were so bad? I can think of two reasons

1. A lot of people do not go into details, and do all sorts of calculations. They tend to go with what the agents sell them. 
2. Traditionally, LIC was the only major player in this field, but now, with a lot of private players coming to market, I think the trend may change.

So, do you have a LIC plan? Or are you planning to buy one? Or would you rather separate your insurance and investments? Do post your comments/ questions.