In the case of guaranteed plans, there is a cost of providing a guarantee and hence returns to the policyholder is lower than a regular plan.
Who will not wish for a fixed and a guaranteed income by investing some money? As an investor, if one is asked to invest today and get the returns or guaranteed benefits at a later date, the offer seems to be very tempting. Generally, life insurance companies offer such guaranteed return plans that come with a guaranteed flow of income in the later years after paying a certain amount in the initial few years. Sample this – Pay Rs 1 lakh for 5 years and after five years start getting Rs 1.5 lakh for another 5 years! Or this – Pay Rs 1 lakh for 5 years and get Rs 10 lakh at the end of 15 years! There are several guaranteed return life insurance plans with a varying structure providing a guaranteed income to the policyholder.
Without getting into the calculation part, for most investors, these are high return plans. For some, these plans are at least helping them to save for their long term needs and assuring them of a regular income. Nothing wrong in such plans, however, as an investor one needs to be aware of the effective returns or the in-hand returns or the annualised returns on the premium paid each year. Even the best guaranteed income plan will not have returns higher than 7 per cent over a long duration.
The returns in a life insurance policy can be calculated by using the formula of Internal Rate of Return (IRR). As the inflows or the survival benefits are not regular while the outflows a premium may not be for every year, IRR helps in arriving at an annualised return giving a rough estimate of the return to the policyholder.
One can use the excel sheet to calculate the return in a life insurance policy.
Here, we take a simple example of an endowment plan in which one has to pay Rs 1 lakh for 5 years and will get Rs 1.5 lakh from the 10th to the 15th year.
- Open a excel sheet
- Enter the premium figures as a negative figure as premium is an outflow. In the table below, Rs 100000 is shown as a negative figure for 5 years. (B1 to B5)
- Enter the amount that you will receive ( Rs 150000) as a positive figure from the cell. (B11 to B15)
- In the cell below, enter the formula for IRR
- On pressing Enter Key, the result will be shown.
Being insurance plans, there is a death benefit in them in which the sum assured and the bonuses or guaranteed addtions are paid to the nominee.
The returns from the life insurance plan either in a bonus based plan or a guaranteed plan are around 6 per cent. In the case of guaranteed plans, there is a cost of providing a guarantee and hence returns may even be lower. For younger age, the return is more than returns for older age. The returns are, however, tax-free in nature. Such plans suit those who need a fixed and assured amount on maturity and will not want to take any risk with their savings. And once purchased, make sure to run them till maturity as any exit before maturity will be very costly in life insurance plans.