Endowment Plan with Guaranteed 3.77% IRR

I did not take note of this plan until an agent friend ask me about it when her client consulted her. She could not believe that such plans exist. Yes, such endowment plans do exist.

Endowment, or for that matter, Participating (Par) or With-Profits plans, have bonuses that will be declared yearly. The bonuses are made up of 2 components, Guaranteed and Non-Guaranteed amounts. As the name suggests, the Guaranteed amount is guaranteed by the insurance company while the Non-Guaranteed amount depends on the performance of the Par fund. Normally, the Guaranteed amount is very low and the Non-guaranteed amount is very high, making the total amount look good. The argument is that if the Guaranteed amount is too high, the insurance company is not able to generate the potential returns from investment which is subjected to volatility. In many cases, the Guaranteed amount is even lower than the total premiums paid, which to me, does not make sense. How can a policy-holder be guaranteed a lower amount than what he put in for a policy that stretches over decades? Have insurance companies fulfilled the Non-Guaranteed projections? My personal experience from reviewing client’s portfolio tells me that the answer is NO! Having said that, it is also highly unlikely that nothing from the Non-Guaranteed portion will be given. The only problem is how much of it.

This particular endowment plan is a 20 year limited premium plan with a 30 year maturity. The Guaranteed amount for a 30 year old (next birthday) male non-smoker for $100,000 sum assured works out to be 3.77%. If the Par fund delivers 3.75% compounded return, the IRR becomes 3.88% and the Effects of Deductions (EoD) is negative! The Effects of Deductions (EoD)can be seen as the opportunity cost for the policy-holder. It shows the difference between investing in a hypothetical fund at no cost growing at the same assumed rate of return. So, if the EoD shows a positive figure, it means that the policy-holder has ‘lost’ that potential amount of return due to cost. A negative number indicates that the policy-holder has not incurred any cost and have gain extra returns. The Guaranteed IRR for a $300,000 policy is 3.86% and 3.97% if the Par fund achieves 3.75% compounded growth!

What does this mean for the insurance company? The company may lose money if the Par fund returns 3.75%. or below. Realistically, it is not far-fetched to assume a compounded return of more than 3.75% over 30 years. It is definitely achievable.

So why is this company able to give such high Guaranteed amount for this particular plan? My personal take is that

1. The company controls cost well. It spends less on advertisement, commissions, annual trips for advisers etc.
2. Historical returns have been good and a good buffer have been built up. They are confident of delivering good long term investment returns. However, historical return is not indicative of future returns.
3. This plan comes with minimum coverage, which makes sense as this is an endowment plan and not a protection plan. Thus cost of insurance is low.

Achieving reasonable return through insurance is definitely possible. When too much emphasis has been placed on motivating advisers instead of delivering the promise, policy-holders can be left disappointed.

No related posts.