Why endowment plan, a traditional life insurance scheme, is part of most household finances

Life insurance plans allow income earners of a household to ensure that in the unfortunate event of their death, their dependents are not cash-strapped and can continue to meet their day-to-day expenses and other financial commitments. It is one of the essential tools to have in a household’s financial portfolio. In return for the life cover, policyholders must make regular payments, also known as premium, to the life insurance company.

In India, among all the life insurance products available, endowment plans, a type of traditional life insurance plan, occupy a significant share in the life insurance market and household financial portfolios, including that of low-income households. Unlike term plans that provide only life risk cover, these plans also offer maturity benefits upon survival by combining life cover with investments. Further, unlike unit-linked insurance plans, where the returns on investments are market-linked and hence not guaranteed, endowment plans assure policyholders a minimum guaranteed return.

Protecting Indian households from life risks: Are endowment plans enough?The life cover offered, per rupee of premium paid, varies by product. Endowment plans, being composite plans, offer a small life cover per rupee of premium paid compared to term plans. A nominal life cover of Rs. 1 lakh for a 30-year-old would cost around Rs. 5,000 per annum under a 20-year endowment plan. The same premium would provide a life cover of over Rs. 10 lakhs under a 20-year term life plan.

While term plans seek actuarially determined premiums only for life cover, endowment plan premiums encompass two components — a sum that goes towards buying life cover and the remaining that goes towards investment. Endowment plans are thus primarily investment products by function, and they significantly fall short on life cover needs.
Adequate life cover should ideally ensure that families are protected against life risks, by helping them tide over the resultant income loss over at least a few years. The low life cover of endowment plans is a serious concern since it gives a false sense of security. In the above example, a Rs. 1 lakh death benefit paid to the family of a 30-year-old who earned Rs. 20,000 per month would be grossly inadequate to cover lost income for even a year. This does not help the cause of closing the mortality protection gap in the country (measured as a percentage of protection needs), which stood at 83% in 2019.Do endowment plans make good investments?As an investment instrument, endowment plans typically provide suboptimal returns. For example, participating endowment plans, i.e., where the insurer’s profits are shared with policyholders, provide a return of only around four per cent to five per cent per annum on the premium paid. One might argue that these returns are justified as they provide a safe, low-risk avenue for households to park their savings. However, the returns offered under these products fail to cover the risk of inflation, considering their long-term nature.

Further, a product feature that does not get prominence in sales conversations is their surrender terms. Endowment plans require regular premium payment, and policy surrender terms heavily penalise policyholders for premature exit. Such withdrawals can result in a significant loss of invested money. For instance, if a policyholder were to surrender the Rs. 1 lakh cover 20-year endowment plan after paying a cumulative premium of Rs. 25,000 for 5 years, the insurance company would return only around Rs. 12,000.

The low returns and inflexible surrender terms make endowment plans unsuitable as an investment option for most Indian households. Studies have shown that households stand to do much better, on both life cover and investment returns, by buying a term plan and investing the rest in alternative instruments such as Public Provident Fund (PPF) accounts than by directing the whole amount to an endowment plan.
Have endowment plans outlived their time?The expert committee set up by the Ministry of Finance in 2014 and chaired by Sumit Bose, former finance secretary traced the genesis of traditional plans, such as endowment plans to the nascent financial markets of a newly independent India. With underdeveloped capital and bond markets and consequently limited investment avenues for the public, these plans provided an alternative channel to mobilise household savings. For households, traditional life insurance plans offered a low-risk investment avenue with life cover. However, the financial markets have advanced since then, prompting the committee to question the lack of reform in these plans.

With decades of presence in the life insurance market and propelled by sales through community-based agent networks, endowment plans have come to represent a default option for most Indian households for their life cover and investment needs. Given that they fail to meet these goals suitably, is it time we critically re-evaluated endowment plans in the present-day context and asked the question how can we better serve these financial needs of Indian households?