Sunday, December 22, 2013

Is an insurance plan with guaranteed payout of 135% good?

"Invest 1 lakh per annum for six years and get 1.35 lakhs guaranteed returns for the next 6 years" or "An insurance plan with guaranteed payout of 135% of premium amount". The offer sounds nice, especially with all the negativity surrounding ULIPs and inconsistent performance of ELSS plans. Anyone yet to think about filling up investments for the 80C quota for this year, would really be tempted.


So is it good?

As always, there is no good and bad here. But one needs to do own calculations to see if it is the best suited and whether it provides value for money. 

Since the plan guarantees returns, let us try to compare it against bank FDs. Let us put 1 lakh in a tax saving bank FD for 6 years, which provides a conservative return of 8%. For simplicity, let us take yearly compounding. The maturity value at the end of the 6 year term will be Rs.1,58,687. 

But what about insurance? The plan in question offers a sum assurance of 10 times the annual premium. So Rs.10 lakhs in this case. A term plan from the same insurer costs less than Rs. 1800 for a cover of 10 lakhs and term of 12 years (for a 35 year old male). So if we consider buying the term plan, we need to adjust the cost for 12 years (i.e. 1800 x 12 = 21,600) while calculating the returns for our FD. Again for the sake of simplicity, let us spread this amount during the first 6 years, where we are investing. So the investment amount is Rs. 96,400 (i.e. 1,00,000 - [21,600/6]). The corresponding maturity value at the end of the 6 year term will be Rs.1,52,975. 


Remember that each of the first six year will involve a payment of 1 lakh each, out of which 96,400 will go to the FD investment and the remaining towards insurance premium. So from year 7 to year 12, the payout will be Rs. 1,52,975 (or 153% in marketing lingo)! Compare this against the guaranteed return from the plan!!

The one benefit that one will not get from the FD + Term plan option would be the tax on returns. Returns from insurance products in not taxable. But the returns from tax saving FD is taxable and will eat into the maturity value. But given that the gap between the two plans is almost 18,000, FD + Term plan option will still beat the guaranteed insurance plan by a handsome margin.

Now that the numbers are worked out, do you still think the plan is good? Let me know in the comments section.

Disclaimer: The views posted in this blog are my own and are based purely on my own way of assessments. Readers are requested to consult with their financial/ insurance advisers before making any investment/ insurance decision, do their own due diligence and validate factual information.

2 comments:

saikat said...

Dear Ganesh,

Given your expertise in insurance, I was wondering if you could advise me on how to select the best health insurance policy for my parents. My father is 63 and mother is 58. It would be great to have a discussion with you on this. My email ID is saikedelia@gmail.com.

Many thanks in advance for your help! Would really appreciate it as I am truly confused right now.

Warmly,
Saikat

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