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Protecting Savings Investment Plan

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By now we know that the sole purpose of an Endowment Plan (with a Waiver of Premium Rider) is to ensure the continuation of the savings/invest plan of the householder in the unfortunate event of her death, and thereby ensuring the achieving of her aspirational goals for her dependents. Do not ever look upon an Endowment Plan as an investment by itself.

A question that may arise in your mind at this point is : can’t this objective be achieved by a Term Plan ? It is often said : Buy a Term Plan, and invest the rest. This old adage is very good, always to be followed. But, as we saw earlier, there is one particular need that is difficult to be satisfied with a Term Plan : protecting a savings and investment plan. You may say, even that can be done – buy a Term cover for the target amount of your savings/investment plan. Your aspirational goals for your dependents can then be protected. For instance, if you would like to create a corpus of `10 lakhs for the higher education of your daughter, you can take a Term cover equal to that amount. Then, even in the unfortunate event of your death, your goal will be achieved. Yes, that is possible. But, is costly. Let us compare the cost of such a plan (Term Plan) and an Endowment Plan with WOP Rider with an example.

To keep the comparison simple let us assume that the risk premium or the mortality charge (net of expenses in the case of Term Plan), per thousand rupees of cover sought is the same for both term and endowment. Let us also assume that the expenses loaded onto the premium are same for both the type of policies. Then the cost of cover will depend solely on the size of the cover.


Now, let us begin with the illustration to understand the superiority of Endowment with WOP Rider (Alternative 2) over a Pure Term Plan (Alternative 1) . Let us suppose that you have calculated that you would need to save and invest `50,000 per year for 10 years to provide for the higher education of your child (let us suppose your child is 8 years old, and she would need this amount at age 18). In 10 years you expect this investment to grow to `10,00,000 at 12% rate of return.

If you buy a Term Plan you will need a cover of `2,67,000. That’s because `2,67,000 plus `50,000 will grow to `10,00,000 over 10 years at 12% rate of return. In the second alternative you need to cover the premiums payable by you to the insurer for 10 years. How much cover will you need to do that ?   Let us use a simple method to calculate that.

If you die after the payment of the first premium, the premia payable by the insurer will be `50,000 X 9 = `4,50,000. If you do not die till the maturity, the premia payable by the insurer will be zero. In the first year, therefore, the insurer takes a risk of `4,50,000 on your life; we call this the sum at risk. Therefore the insurer will charge you risk premium on `4,50,000 in the first year. In the second year the sum at risk is `4,00,000; in the last year the sum at risk is zero. So, on an average during the 10 years the sum at risk will be `2,25,000; so during the period of ten years you will be charged risk premium on a WOP cover of `2,25,000.

From the above it is clear that the cost of cover in the first alternative is higher than the cost of cover in the second alternative. That is because the first alternative requires you to carry an increasingly redundant cover as time passes; you are paying for a cover which you do not really need. How much redundant cover are you paying for ?

`42,000 X 10 years = `4,20,000. You are paying for an excess cover of `4,20,000. Therefore, a Term Plan as an alternative for Endowment Plan with WOP Rider is a costly option. Your goal of protecting your savings and investment plan can be more economically met by an Endowment Plan with Waiver of Premium (WOP) Rider.

How much premium should you pay for the Endowment Plan you buy for that purpose ? Your premium should be equal to the savings / investment you had in mind for your aspirational goal for your dependent.

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