What is Endowment Plan?

Endowment plan is a combination of insurance and investment. In term plan which is a pure insurance there is no maturity benefit. It means if a person dies during the term of policy then only his beneficiaries will get some money otherwise at maturity, at the end of the term there is no benefit.

In endowment because as I said it is a combination of insurance and investment it means if during the term of policy that life assured dies in such case beneficiaries will get the benefits. Benefits are sum assured under the policy and also if there is bonus or guaranteed returns or something that will also be paid to the beneficiaries.

However if the person survives throughout the term of policy at the time of maturity whatever sum assured plus other benefits in form of interim bonus or vested bonus that will be paid to the person himself who has bought the policy.

There are certain things that individuals should understand about endowment policies.

1.An endowment policy is a combination of insurance and investment:

The life of the individual taking the policy is insured for a certain amount. This life cover is referred to as the sum assured.

A certain part of the premium gets allocated towards this sum assured. Some portion of the premium is allocated towards the administrative expenses of the insurance company selling the policy. The remaining portion of the premium gets invested.

2. An endowment policy may declare a bonus every year:

The money that is invested generates a certain return every year. This return may be declared as a bonus. The bonus is typically generated as a certain proportion of sum assured or life cover as it is popularly known.

So if an individual taking the policy has a policy of sum assured Rs 10 lakh and the company declares a bonus of Rs 50 per thousand of sum assured, then the bonus works out to be Rs 50,000

3. The bonus declared is not payable immediately:

Like is the case with a stock dividend or a mutual fund dividend which is payable immediately after it is declared, the bonus declared accumulates and is payable only when the policy matures or in case the policy holder dies.

4. The bonus declared does not compound it, only accumulates:

Let us take the case of a 35 year old individual who takes a policy with a sum assured of Rs 10 lakh with a term of 20 years.

The premium for this would be around Rs 49,000 per year. At the end of the first year, the insurance company declares a bonus of Rs 50 per thousand of sum assured or 5% of sum assured. This amounts to Rs 50.000. This Rs 50.000 remains Rs 50.000 for the next nineteen years till the end of the policy. The same thing happens to the bonuses declared for the remaining period of the policy as well.

5. Since the bonus declared does not compound returns are low:

Extending the example taken above, let us assume that the insurance company declares an average bonus of 5% every year. What this means is that every year on an average a bonus of Rs 50,000 is declared. So at the end of twenty years, the total accumulated bonus would amount to Rs 10 lakh (Rs 50,000 x 20).

Chances of an insurance company declaring an average bonus of more than 5% over a period of twenty years are very less. This is primarily because endowment policies largely invest in government securities and after taking into account the administrative expenses of the insurance companies, a greater bonus is highly unlikely.

So at the end of twenty years, the individual gets Rs 10 lakh of accumulated bonus and Rs 10 lakh of sum assured, making a total of Rs 20 lakh.

On this he has been paying a premium of Rs 49,000 every year. This amounts to a return of 6.39% per annum, which is not great. If the individual expires during the period the policy his nominee gets the Rs 10 lakh of sum assured as well the accumulated bonus till that point of time.