How Are Endowment Plans Different From Other Life Insurance Plans?

  Author: Naveen Kumar

All life insurance companies provide endowment plans. So, it makes sense for a prospective buyer of a life insurance plan, to get an idea of endowment plans and other categories of life insurance plans while scouting for the best life insurance plan for him or her.

When it comes to endowment plans, there is one of thing you need to keep in mind. Unlike a pure protection life insurance plan, like term life insurance plan or term plan, where your nominees only get the life insurance amount in case of death, or return of premium, if it is a return of premium plan, here, it is a combination of life insurance and investment.  Of course, apart from term plans, most other life insurance plans are essentially life insurance-cum-investment financial products. So, what distinguishes endowment plans? Here are some major distinguishing features:

Investment risk borne by insurance company In case of endowment plans, the risk from investments made by the life insurance company is borne by the life insurance company. This is not so in case of another category of unit linked insurance plans (Ulips) where it is you who bears the investment risks.

Type of returns Unlike endowment plans which announce bonus based on the profits made from the investments out of the money raised from policyholder premiums, returns from Ulips depend on how the investments. Since endowment plans typically invest in lower risk, fixed income investments, the policyholder can typically expect some bonus accruing in with-profit policy, and loyalty addition in without-profit policies.   

Low returns While the lower risk profile of the endowment plans provides reasonably predictable returns in terms of bonus but they typically lag behind the inflation i.e. bonus rates are typically Rs 55-60 per thousand of sum assured in a year or Rs 5,500 to Rs 6,000 for Rs 1 lakh of life insurance . Since these annual bonuses are paid only after maturity and do not grow during the intervening period therefore the final return on investment remains typically around 5-6 per cent.

At the same time, unit linked insurance plans (Ulips) invest in higher risk investments like equities. Regular investments made over 8-10 years or more help get returns that beat inflation. For instance, adjusted for various charges, well-performing Ulips would have typically provided returns in the range of 10-12% in the last 10 years. 

Understanding the difference between life insurance endowment and other plans like Ulips is important as many endowment plans are pitched as vehicles to fulfill major life goals like children’s higher education. The fact that they will struggle to beat inflation, makes them inappropriate for fulfilling major long term needs. This is despite the fact that all life insurance plans get the same tax benefits. You get annual tax deduction of upto Rs 1.5 lakh under Section 80C. The death benefits are also exempt of tax under Section 10(10)D.

In this discussion, it is worthwhile touching on a related topic. You are likely to come across the reasoning that endowment plans are great for those who don’t want to take risk and want predictable returns. This contention is clearly fallacious with risks from inflation not being accounted for. Thanks to lower risk, with fixed income investments, over the long term, the growth of your savings in an endowment plan typically gets dented by inflation.