How to calculate returns from an insurance policy

How to calculate returns from an insurance policy

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Here is how you can calculate returns from an insurance policy. The next time an insurance agent shows you a policy benefit illustration or the next time your friend or relative asks you, “Is this a good policy to invest in?”, use this method to show the annualized return they can expect (before bonuses which will not make a significant impact).

Let us take an example of PNB MetLife Guaranteed Savings Plan. This illustration was shared in FB group Asan Ideas for Wealth a few days ago. I love this example because it teaches always to compute XIRR and NOT IRR!! For those who an introduction to these terms, please consult: What is XIRR: A simple introduction

There are so many variations possible with these numbers to illustrate the time value of money. I have already done one example here: Why Time is Money and How Life Insurance Plans Exploit it! When I can, will make a video on the variations. For now, I will stick to the numbers as given by the insurer.

Shown below is an illustration for a 20Y policy with 10Y premium paying term. The sum assured ~ Rs. 5.56 Lakh and the annual premium is Rs. 50,000 or Rs. 59,000 with GST (notice that illustrations will not include taxes). These premia are shown as upward blue arrows below.

At the end of 20Y, the policy will pay out Rs. 7,23,992 as a guaranteed benefit. It will pay out Rs 2,75,000 over the first 11 years of the policy in the following manner. After one year, the total premium paid is Rs. 50,000. So in the second policy year, 10% of this amount or Rs. 5000 will be paid.

In the third policy year, it will pay 10% of total premiums paid so far (Rs. 1 lakh) or Rs, 10,000 and so on. These are shown as the red down arrows that increase in size. The sum of all these payouts is Rs. 275,000. Now how to compute annualized returns?

First, we need to tabulate all the cash outflow and inflow as below.

  • Col A is just the year no starting with zero (the 1st premium).
  • Col B a set of imaginary premium paying dates. We shall assume the annual payout from the insurer is also on the same date
  • Col C the premium paid (before GST)
  • Col D the sum of total premiums paid each year.
  • Col E actual premium paid (including GST). Shown as negative for return calculation. The money we pay is shown as negative and the money we receive is positive.
  • Col F 10% of cumulative premiums paid is given to us (so this is positive).
  • Col G is the total cash flow that is the sum of Col E and Col F.  The final payout of Rs. 7,23,992 is shown as the final entry (20th year).

The XIRR or annualized return formula is as shown below. The XIRR formula is = XIRR(set of cash flow values, dates)


Insurance policy XIRR calculation

The annualized return is 5.11%

Note: IRR (a variant of XIRR for regular cashflows and therefore dates are not used) gives an inflated wrong answer. I have not dug deeper into this problem. This example shows that it is better to use dates + payouts and use XIRR at all times.

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  1. This does not consider the benefit you availed for life insurance. Term insurance amount should be deducted from the calculations for sir, in my opinion.

  2. Well I get the message (But unable to explain this to my dad :'() , but isnt the gst on endowment policy 4.5% for 1st year and 2.75% for rest premiums? Is this not an endowment policy?

  3. Isn’t the 10% of cumulative premiums paid a guaranteed addition? Which means you actually get the money after 20 years. So column G’s first 10 entries should be actual premium paid and G21 will be sum assured + the whole of additions. The XIRR will be a lot less then. I got around 4.32% with lesser GST than 18%

      1. Umh. I went through the policy documentation again. They say 10% of premiums paid is added and it is a maturity benefit. So one pays a premium of 50000 every year and get the guaranteed bonus at the end of 20 year. One doesn’t get each addition every year in hand so money outgo each year is premium (not premium – addition). So agree to disagree.

        1. You can disagree all you want, but the link provided above makes it clear “Guaranteed additions are added at the end of each Policy Year during the Premium Payment Term (provided all due Premiums have been received for that Policy Year) “

          1. Yes. They are added meaning guaranteed additions are getting accrued to the account. But reception only at the death or maturity. Thats how an endowment policy works. That is basically accruing.
            If you see the maturity benefit – It says
            On maturity, your benefits will be

            Sum Assured on Maturity plus
            Accrued Guaranteed Additions
            Same for Death benefit.
            The payout is on maturity or death not yearly.

  4. What about market linked policies such as HDFC pro growth SL II. How to calculate returns? There is no annual payout but only a lumpsum payment in the end.

    I created a worksheet and the high fees and expenses mean that over the last three years, I am 12% below the returns based on NAV. Would you like me to share my worksheet for others to benefit?

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