This episode 2 we are going to instill awareness on the options you have when you want to save for a major financial goal in the future. Like child education. The first come to mind is endowment insurance policy or savings plan. These plans are sold to non-savvy public who buys the idea of having a 2 in 1 feature in an insurance policy – Protection and Get back some cash – very good right? Kill 2 birds with one stone. They normally have the characteristics below:
- Some protection* (coverage) for death and permanent disability
- Runs for a specific time (say, 20 to 30 years, but very rarely, until age 99). Also known as maturity period
- Payout the sum assured when covered event occurs or at the end of maturity period, whichever comes first
- Guaranteed interim cash payout at regular intervals as defined in the policy
- Non-guaranteed bonus payout at end of maturity period
The reason I state “Some Protection” is because you could get a better pure protection by the same premium. In other words, you could get a much larger sum assured by paying the same amount of premium for an investment-linked or term policy.
When there is cash outflow (you paying premiums) and cash inflow (interim guaranteed cash payout and the basic sum assured payout at the end of maturity period), there is only ONE WAY to determine the “investment return” of such plans, in percentage.
That method is Internal Rate of Return (IRR).
After we get the IRR, then we only can do apple-to-apple comparison with investment returns, like FD rate of 3%.
Watch this video, but to simplify thing, if your IRR is less than Fixed Deposit rate, it means this plan make less money than Fixed Deposit rate over the same period of time. Capisce?
Lesson today is, while these kind of plans appear to be providing both protection and income – killing 2 birds with 1 stone, NOT every kill-2-bird-with-1-stone stuff is good. The reason is simply, for the price you are paying – you are neither getting sufficient protection nor getting sufficient return for your money.
Therefore, whenever you are being presented with such plans, just ask 2 things:
- What is the IRR
- …and IRR should only be computed taking into account the guaranteed cash payout (whether interim or final).
Don’t give a damn the non-guaranteed bonus because it is NOT something insurance company, your agent and any advisor can guarantee that. Skip the marketing part, the projection or any “number dressing.”