Most buyers of life insurance policies, because of their own ignorance or the hard-sell of agents, end up buying life insurance policies without clearly under- standing their financial needs. Alternately, the considerations that resulted in buying the policies may not be valid anymore. However, once a policy is bought, they feel hostage to it and paying premium becomes a fait accompli for the rest of its tenure.

At the core of this dilemma is a lack of understanding of the provisions of the policy and a reluctance to take some hard decisions in the short term to get better results over the long term. Some calculations can help you get a complete picture for yourself and empower you to choose what works best for you.

Life insurance policies have a lock-in period of three years. After that, you can terminate it whenever you want. On completing three years, the policy acquires a guaranteed ‘surrender value’, which is typically 30-50 per cent of the total premium paid till the date of surrender, excluding the first-year premium. The actual surrender value can be higher than the guaranteed value, based on the bonuses declared by the insurance company. The details for computing the guaranteed surrender value are generally published in the policy document.

There’s no denying that surrendering the policy at an early stage will result in a loss. However, if you exit and start investing in a product that can deliver higher returns, not only can you wipe off your loss, you can also end up with more money than you would have had in the endowment plan.

Sharma has three insurance policies, each of which is a 20-year plan. One is in the fourth year of its tenure, another in the fifth and another in the sixth. The first two policies have an annual premium of Rs 30,000 each, while the annual premium on the third one is Rs 40,000. If he surrenders his policies today, the guaranteed surrender value that he will receive is Rs 1.05 lakh, against the total premium paid so far of Rs 3.9 lakh — a loss of Rs 2.85 lakh. That was the figure the agent highlighted and put him off. But that’s only one side of the story.

The other side, few tell; or if they do, they don’t do it through the prism of numbers. Over the past 20 years, LIC endowment plans have given an effective return of 7 per cent a year. Remember, till the late-nineties, interest rates were absurdly high, and are unlikely to reach those levels again. In other words, 7 per cent is the best-case scenario. Even then, endowment plans, sometimes, come out second best.

Sharma’s three endowment plans, if they continue to return 7 per cent a year, will give him Rs 44 lakh after each has completed 20 years. If Sharma invests the surrender value (Rs 1.05 lakh) and future premiums (Rs 1 lakh a year) in an instrument that delivers an annualised return of 11 per cent over the years remaining to 20 years, he will end up with a maturity amount of Rs 50 lakh — Rs 6 lakh more than the insurance plans. At 15 per cent a year, which is a realistic expectation from equity funds over such long periods, his payback will be Rs 75 lakh. At 18 per cent a year, it’s Rs 1 crore. Such a mid-course correction works when you don’t need the life cover and your policy is in its early years. Closer to the end of the tenure, a premature exit is not recommended, as you won’t get enough time to make good the losses, leave aside bettering them (See table: There’s value in surrender).

Like Sharma, if you have made a mistake buying a low-returning endowment plan, or if the amount of life insurance you need has reduced or your appetite for risk has increased, restructuring your life insurance portfolio can strengthen your overall portfolio. And leave you richer.
The writer is CEO, Cornerstone Wealth Management

Early in the tenure, it pays to prematurely exit an endowment plan you don’t need. But late in the tenure, it doesn’t. Take a 20-year, endowment plan, on which the premium payable is Rs 1 lakh a year and the sum assured is Rs 20 lakh. At a bonus of 7 per cent a year, you will get back Rs 46.9 lakh after 20 years. If you can get sizeably more by switching, it’s worth it. In Year 5, there’s a clear-cut case to take the surrender value and reinvest it in higher-earning instruments -- even at 11 per cent a year, you end up with Rs 55 lakh. In Year 10 and Year 15, though, 11 per cent doesn’t fetch you much more, and a switch is worth it only if you can earn 15 per cent.