Endowment policy is basically a life insurance contract between the insurer and the insured whereby the policyholder pays premium and in return covers his risks. Premium for endowment policy is higher in comparison to traditional whole life policies and term insurance plans. An assured sum is paid either on a fixed date to the insured or on his death to his nominee, whichever comes earlier.
Advantages of Endowment Policy
- Provision of life insurance protection is the basic feature o endowment policies
- In addition to life insurance, endowment policy consists of savings and investment element in it.
- There is a flexibility to choose the time of maturity and the amount you want to save each month.
- You can use the amount of endowment to meet your financial needs like your child’s college fees, daughter’s marriage, etc. if and only if you survive the period. Otherwise, if you die before the maturity date of the policy, then your nominee will get your death benefit and your family’s financial needs can still be met from the amount.
- Endowment policies are free from investment risk and interest rate risk.
- It also includes non-forfeiture privileges.
Disadvantages of Endowment Policy
- Protection provided by this policy is for a specified period only.
- Returns from this policy are low which means you cannot think of accumulating wealth from these policies.
- Due to inflation, the benefit you are thinking today might not give you the same advantage at the time of maturity.
- High rate of premium in comparison to whole life insurance or term insurance plans.
- Option to renew or to convert the policy into term insurance is not provided by most of the companies.
Understanding Endowment Policy with the help of an example
Let us say, a person has opted for an endowment policy for 30 years with annual premium of Rs. 31,000. Sum assured (in case of death of the policy holder before maturity) is 10 lakhs and maturity amount (applicable only if the policy holder survived the tenure) is Rs. 23, 10,000.
For 30 years, total premium paid amounts to Rs. 9, 30,000 (31000 * 30).
Maturity value can be calculated with the help of following formula:
Amount paid per year as premium * [{(1+r) ^ n-1}/r] * (1+r)
Where, n is number of years i.e. 30 in this case and r is rate of interest
Now, if we put the available values in this formula, it will be
23, 10,000 = 31,000 * [{(1+r) ^ 30 – 1}/ r] * (1+r)
This condition will be satisfied at a value of 5.4% for r.
Since r is the rate of interest, with these values, your endowment plan will yield you a return of 5.4% only. Whereas, rate of interest on a fixed deposit is 9%, mutual funds also give you a return of 10-12%, PPF also offers an interest of 8% and there are ‘n’ number of products in the market that can provide much higher returns in comparison to endowment policy.
Rather than blocking your funds in endowment policies, it is better to choose products that offer a mix of insurance and investment and yield a better rate of return at same or less cost. However, being an investor, you are the king of your own choice. Your agent may present the things to you wrapped in a very attractive way, but ultimately you got to identify the real picture covered under his tempting statements.
There is one piece of advice:
Make a comparison of available choices; understand your requirements and your premium paying capacity; identify the pros and cons for each of the available options as per your requirements and then take an informed and calculated decision.
