How term plans score over the rest

A term plan is a pure risk cover plan wherein the insured pays a lower premium for a higher sum assured. Term insurance is the cheapest form of insurance and helps the policy holder insure himself for a larger amount at a relatively low premium. Unfortunately, for the ‘returns sensitive’ investor, term plans do not find favour, as they do not offer a return (although some term plans do return the premiums paid if the individual survives the tenure).

Term plans are cheaper than other forms of insurance because of their lean cost structure. Only the administration expenses and the mortality charges are covered in the term plan’s premium; there is no savings element in the premium charged to the insured. Therefore, if the insured were to survive the tenure of the plan, he gets no returns. Effectively, the premiums paid towards this plan are completely written off if no eventuality occurs during the tenure of the plan. Only in case of an eventuality do the individual’s nominees stand to ‘benefit’ by way of receiving the sum assured. 

For the ‘money-minded’, term plans appear too drab; it’s endowment plans that get their pulses racing. In life insurance parlance, endowment plans are referred to as ‘with-profits plans’. They cover the individual’s life in case of an eventuality; if he survives the term he receives the maturity amount. In the event of the individual’s demise, his nominees receive the sum assured with accumulated profits/bonuses on investments (till the time of eventuality). In case the individual survives the tenure, he receives the sum assured and accumulated profits/bonuses. 

Both term and endowment plans can be understood better with the help of illustrations drawn from existing policies of a leading life insurer. Let us consider the case of a 30-Yr old individual who wishes to get insured for a sum assured of Rs 1,000,000. He considers a term and an endowment plan for the requisite sum from insurance company XYZ.

In case of the term plan for Rs 1,000,000, the annual premium amounts to Rs 3,430. Over 30 years, the total premium amounts to Rs 102,900. There is no maturity amount if he survives the tenure.

If an endowment plan of Rs 1,000,000 were to be chosen, the annual premium comes to Rs 29,820. Over 30 years, the total premium paid will be Rs 894,600. Assuming returns at 6% per annum, the maturity amount for the endowment on maturity would be Rs 3,357,515 i.e. Rs 2,357,515 towards the bonus and Rs 1,000,000 for the sum assured. 

One glance at the disparities in the premium amounts (of term and endowment plans) is enough to prove that endowment plans can be very expensive. That is why we find it strange when we meet clients who are partial to endowment plans. From our client interaction, we have learnt that there are two important reasons why endowment plans nose ahead of term plans in the individual’s books: 

1. Fear of forfeiting money (read premium). In a term plan, if a person survives the tenure he stands to forfeit the entire premium, which is not the case in an endowment plan. 

2. To earn returns. Most individuals even while taking life insurance, which is all about covering one’s life, want something in their hands (read returns) at the end of the day. If they don’t get a return, they perceive the product (in this case term plans) as ‘boring’. Since endowment plans declare a return, individuals opt for them notwithstanding the higher premiums. 

At Personalfn, we have maintained that ideally, insurance and investment requirements should be tackled distinctly. On these lines we analyse various alternatives at the individual’s disposal to enable him to make the most of his investments by keeping his insurance cover costs to a minimal. 

From our illustrations it is apparent that for the same insurance cover (Rs 1,000,000), a person pays Rs 102,900 (over 30 years) in the term plan whereas in the endowment plan he invests Rs 894,600 i.e. an additional Rs 791,700. We recommend that the individual takes the low cost term plan and invests the balance premium in a market-linked investment. 

Now let us consider two scenarios – one of an investor with a high-risk profile and the second of an investor with a low to moderate risk profile.

*In a term plan the sum assured is given back only if the person expires before the term, else there are no returns. 

1. The investor with a low to moderate risk appetite should consider investing the surplus sum of Rs.791,700 in a hybrid mutual fund that has moderate equity exposure (upto 30% of net assets). Our calculations indicate that over 30 years a mutual fund with upto 30% in equities is well placed to give a total return of Rs 19,944,592. For an investor in the highest tax-bracket, the return would amount to Rs 13,195,376. 

2. For the high-risk investor, we recommend that he invest the surplus sum of Rs 791,700 in diversified equity funds. We believe that a well-managed diversified equity fund can return 15% CAGR over 30 years. Based on that, the investor stands to make Rs 52,149,859. 

Compare the maturity benefits on the endowment plan with what the individual makes on the combination of a term plan and mutual fund investments. In the alternative we have recommended, the individual’s nominees will get the sum assured on the term plan in case of an eventuality. They also have the mutual fund investments that they can redeem completely/partly either at the time of the eventuality or at a later date.

Endowment plans aren’t necessarily bad, but they are not the right avenues for an individual to get a life cover or to put it more accurately to get the cheapest life cover. Endowment plans, especially the money-back variant, can still work well for parents who are providing for a child’s future education, marriage and such other needs. However, to begin with, having a term plan in your portfolio for life cover is a must, other products like endowment plans, and ULIPs can be added based on specific needs.

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