Someone you know sits in your living room in March with a form and a pen — a cousin, a neighbour, a colleague who has just started selling insurance. The plan pays a lump sum after twenty-odd years, covers your life meanwhile, and the premium counts towards a tax deduction. You sign, partly because it sounds like three useful things for one price, and partly because refusing this person is awkward.
What you have bought is usually an endowment plan: a life insurance policy with a savings component built in. It is worth understanding before the next form arrives — almost nobody who buys one has seen what the parts cost.
What your premium is actually buying
Every rupee is doing three jobs at once, and the document does not separate them for you.
- The cost of the cover. Part of the premium pays for the risk the insurer carries on your life.
- Distribution and administration. Commission and expenses come out of the premium, and on traditional policies they are heavily front-loaded into the early years.
- Whatever is left. The insurer invests the remainder. Because it has promised a fixed sum at the end, that money sits in conservative fixed-income instruments.
So the savings part is not your whole premium compounding for twenty-five years. It is the leftover, invested cautiously, after cover and costs.
Why the big number is not a return
The pitch always has the same shape: a small number in, a large number out. Pay ₹36,000 a year for sixteen years and receive a lump sum after twenty-five. Sixteen premiums of ₹36,000 is ₹5.76 lakh paid in, against a maturity figure several times that.
It looks extraordinary because the totals are added as though timing did not exist. Your first premium works for twenty-five years; your sixteenth works for ten; the last nine years have no premiums going in at all. Adding rupees paid across sixteen different years and comparing that to one number in year twenty-five tells you nothing about the rate at which your money grew.
The figure that does tell you is the annualised return, and you can work it out. Put the dates in one spreadsheet column, the premiums as negative amounts in the next, the maturity value as a positive amount on its date, and use the XIRR function. If the illustration shows only totals, you have been shown the flattering version.
Ask the two questions separately
On the cover: what is the sum assured, and what would your family need if your income stopped tomorrow? People often size life cover as a multiple of annual income — a rule of thumb, not a rule. On most endowment plans the sum assured is a modest multiple of the annual premium.
On the savings: what is the annualised return, how much of the maturity value is guaranteed and how much is a bonus that is not, and what do you get if you stop paying in year three? Traditional policies typically have little or no surrender value early on, so the money is far less accessible than a bank balance — an illiquidity that never appears in the illustration.
The tax reason is the weakest reason
Many of these are sold in the closing weeks of the financial year to shrink a tax bill. Certain premiums have historically been eligible for a deduction, which lowers taxable income — but that only helps if you are on a regime that offers it, and India now has more than one. The specifics have changed since this was first written, so check your own position. And a deduction is a one-off benefit on the money going in; it does not change what the policy does with that money for twenty-five years.
Before you sign
- What is the sum assured, and how does it compare with what my family would need?
- What is the XIRR on the illustrated maturity value, not the total?
- How much of that value is guaranteed, and how much is a non-guaranteed bonus?
- What do I receive if I stop paying after three years? After five?
- Does the deduction being described actually apply to me under my regime?
Straight answers mean you are buying with your eyes open. Vague answers are information too.
This article is general information for education only. It is not investment advice and does not take account of your circumstances. Investments in securities are subject to market risks; please read all related documents carefully before investing.
