How to calculate returns from an insurance policy

Published: July 14, 2019 at 11:14 am

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.

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps