Life Insurance endowment Policy converted to numbers:

Agents often coax financially susceptible customers to buy a traditional Life Insurance product. The non suspecting customer often gets lured by the idea that an endowment policy satiates the need for both investment and insurance. You also have the icing on the cake in the form of tax benefits under 80 C.
Here we will try to analyse a typical endowment policy numerically:
So let us assume a 23 year old buys an  endowment policy for a term of 20 years with a sum assured of 300,000 INR. To add a sweetener to the policy, the agent proposes a tweaked version of the traditional policy , where the customer needs to pay the premium "only" for 15 years. As a 23 year old has less risk to life compared to a 43 year old, his premium is comparably lower at 17,312 INR.
The agent promises him, every year a vested bonus gets accumulated. The bonus is calculated as a percentage on the same assured. The deal is finally sealed when the agent tells him that on maturity of the policy , the customer also gets a loyalty bonus.
As the old adage goes "If it sounds too good to be true, probably it isn't".

So let us look at the numbers.

The customer pays 17,312 for 15 years.Total 259,680 INR

On maturity(if the customer has survived this 20 years):

He gets:

Sum Assured: 300,000

Vested Bonus : 228,000 . (Assuming Average Bonus declared over 20 years is 38 per 1000 S.A)

Final Bonus : 21,000. (Assuming Final Bonus of 70 per 1000 S.A)

Loyalty Bonus :10,500 ( Assuming Loyalty Bonus of 35 per 1000 S.A)

Total he gets:559,500

The assumptions are based on 2014 numbers.

So he makes a net profit of :299,820.

Before we conclude that this is phenomenal profit with absolutely no risk, we need to take out our calculators.

These entire series of cash outflows( 17,312 every year for 15 years) and final cash inflow (at end of 20 th year) , equates to an IRR(internal rate of return) of 6.30%.

In simple words this means this is equivalent to a recurring tax free deposit of 6.30% interest rate.

Hang on , we cannot forget the insurance component of the product, after all it was Life Insurance which the customer bought. More so a recurring deposit is never tax free which a Life Insurance is.

So we are comparing apples with oranges.

So to compare between equals lets imagine , the customer goes for a term insurance policy and puts the rest of his savings in PPF. Both of these are again tax free.

So if the 23 year old buys a term policy for a sum assured of 10 lakhs. 

A term policy is a pure play life insurance policy, where the the customer(rather his nominee) only gets the insured amount in the unfortunate event of the customer's death.

Since there is no investment component to these breed of life insurance policies, the premium is far lower.

The most popular life insurance company in India offers a term policy of sum assured 10 lakhs for 20 years to a 23 year old at 2310.

Now he can invest the remainder of his money (17,312- 2310) in PPF. 

Assuming he invests this 15,002 in PPF for 15 years, but withdraws this money after 20 years.

(This adjustment is done to draw parallel with our first endowment Life Insurance policy).

The interest rate in PPF is currently 8.7%.

The investor gets a lump-some amount of 652,893, after 20 years.

Before we forget, we need to adjust for the extra 2310 the customer is paying(as premium of tem policy) for 5 years(15-20th year).

Again at an interest of 8.7% the 2310 premium comes to 13,742 at end of 20 the year.

So in the first policy , the customer pays 17312 for 15 years and gets 

1.  A life coverage of 3 lakhs (+Bonus, max upto 550, 000). 
2. An investment which produces 559,500 after 20 years.

In the alternative policy, the customer pays 2310(for 20 years) as Life Insurance premium, and 15,002(for 15 years) towards PPF.

He gets:

1. A life coverage of 10 lakhs
2. An investment which produce a corpus of 652,893 after 20 years.

So the net difference is :

1. A Life insurance coverage of 5 lakhs more.
2. An extra corpus of 79,651 after 20 years. (Please note: we have adjusted for extra premium : 652,893 - 559,500 - 13,742 )

Conclusion : It is better to segregate Life Insurance from Investment, even though your agent may want you to believe otherwise :).