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What Should I Do With My Endowment Policy?

Question: I am a 29-year old engineering professional working in a large IT company. Three years back, I had purchased an endowment insurance policy for a Sum Assured of Rs.5 lakhs for a 21-year term. My annual premium payout is Rs.23,700. I am not happy with the policy. What should I do?

Answer: There are two clear alternatives (and a third one too) to this problem of getting stuck in a bad investment. As is often advised, ideally one should keep insurance and investment separate.

Alternative A: Surrender it.
One option is to surrender the policy. Now that you have paid premiums for three years, your policy acquires a surrender value. (Note: Up to two years of premium payment, the surrender value is ZERO. So, you get NOTHING AT ALL if you surrender such a policy.)

Having said that, insurance is a long term contract. Therefore, don't expect too much when you surrender an insurance policy. In fact, you will lose a lot.

In the above case, since the policy is relatively new, you will get back only around 30% of the total premiums paid over the last three years.

In other words, while you have paid Rs.71,100 as premiums for three years, you will receive just about Rs.21,000 only. So you stand to lose almost Rs.50,000 upon surrendering your policy.

Alternative B: Continue with it.
Suppose the loss of Rs.50,000 shocks you... and you drop the idea of surrendering the policy.

You decide to continue paying Rs.23,700 premium every year, for a total of 21 years till the policy matures.

Your total premium payout over these 21 years would amount to almost Rs.5 lakhs. And, going by the average bonus payable on such policies, you can expect to receive around Rs.11 lakhs in the 22nd year. This, for your information, works out to an annualized return of around 6.73%... not a very encouraging number.

In short, if you remain invested you will earn poor returns on your investment.

You have THREE choices to make w.r.t. your Endowment Insurance Policy.

So, now what?
If I were in your place, I would bite the bullet. That is, I would surrender the policy and take the hit.

Let's see why:

Sure, I will lose 70% of the premiums paid till date. Yes it will definitely hurt (for some time).

But in the long run, I will surely come out a winner!

We receive Rs.21,000 as surrender value. Plus we have Rs.23,700 which we would have otherwise paid as premium for the next 18 years.

Suppose we switch this investment to a conservative hybrid mutual fund i.e. an MIP mutual fund scheme. Such schemes invest 75-90% of the corpus in fixed-income securities for safe returns, and balance around 10-25% corpus in equity market to improve the returns.

On an average, it is quite reasonable, feasible and realistic to expect around 10% as annualized returns from such MIP schemes over around 18 years of investment period.

If that be so, as against Rs.11 lakhs expected from the endowment insurance policy, we can easily expect around Rs.13 lakhs in an MIP scheme.

And, if we have somewhat higher risk appetite and choose to invest this money in a Balanced Mutual Fund (which invests around 75-80% corpus in equity and remaining 20-25% in fixed-income securities), we can reasonably expect around 11.50-12% annualized returns.

If that be so, as against Rs.11 lakhs expected from the endowment insurance policy, we can easily expect around Rs.15.50-16.50 lakhs in a Balanced Fund.

Therefore, it is better to undergo the painful surgery today, rather than waiting for 18 years for some very measly and pathetic returns. A switch out would open up many options that can give a far better maturity value.

By the way, there is middle path too!

Alternative C: Convert the policy to a partly paid-up one.
Suppose you don't want to lose Rs.50,000; but you also want to start SIPs in suitable mutual funds instead of paying further premiums going forward.

This is possible when you make the policy partly paid-up.

Under this approach, 
a) your insurance cover would be proportionately reduced (and you won’t have to pay any further premiums),
b) the paid-up value of policy will be returned to you on maturity date as per the original policy

In this case, your reduced Sum Insured would be around Rs.71,450. You will get back the Sum Insured after 18 years when the policy matures as per the original policy term. Plus, depending on the terms of the policy, you may also receive the bonus that has accrued during the first three years i.e. additional around Rs.72,000.

This may appear to be a better option than losing money on surrender.

But remember, this Rs.71,450 earns NO INTEREST during these 18 years. So you lose 18 years of interest income, if you convert your policy into a paid-up policy.

And, if you are lucky enough to have a policy that also pays the accumulated bonus of Rs.72,000 (i.e. you receive around Rs.1.43 lakhs after 18 years), your effective returns would work out to mere 3.57% p.a.

So, think about it!

Concluding: Do your calculations under the above-mentioned three scenarios, and then make your choice. Having said that, in the early years of the policy, it's best to surrender your policy or at least make it partly paid-up. Continuing with it would most definitely be a bad idea.

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