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What distinguishes an endowment policy from a pure term insurance policy is that the premium for the former has an additional component .
Investment
Profit to Insurance Company

Marketing and . Administrative Expenses
Risk Premium .

To understand the complementarities between the insurance and investment component in an endowment policy.One way to look at an endowment policy is as a “packaged” product containing two products within : insurance and investment. But this sort of a view overlooks the complementarities between the two. we will have to redefine the protection function of insurance. What does the insurance seek to protect ? .

Financial distress could take two forms :  A threat to survival / maintenance of desired standard of living of the dependents of a householder.  A non-fulfillment of the “aspirations” of the dependents or “aspirations” of the householder for the dependents. .

for which the householder intends to make a financial provision as she works and earns. Education of the children or settling them up in life are the most prominent. the second requires an endowment policy. Let us see why.The first is taken care of by a pure term insurance policy. Aspirations or “aspirational goals” are the desires of a householder for her dependents or of the dependents themselves. .

But an adverse event like the death or critical illness of the householder may upset this plan (as the householder cannot now contribute to the corpus) and leave the aspiration un-fulfilled. are expected to grow into a corpus which would serve to fulfill the aspirations. .As the householder works and earns. The savings invested appropriately. she sets aside as savings a part of her earnings to make this provision.

A pure term insurance policy which pays a lump sum on occurrence of the adverse event can offer relief against the immediate financial distress caused by it in the form of threat to survival / maintenance of desired standard of living of the dependents of a householder. . But it cannot ensure the continuation of the savings/investment plan.An insurance policy that seeks to offer protection against this financial distress should ensure the continuation of the savings and investment plan.

The fulfilllment of the aspiration is therefore protected.An endowment policy with a waiver of premium rider” can ensure the continuation of the savings/investment plan. The plan therefore continues. the insurance company pays into the policy account the premium that the policy holder would have paid. On occurrence of the adverse event. . thereby creating the corpus that the householder had envisaged.

Investment Insurance .

 That is the complementarity between the insurance and investment component in an endowment policy. .

There are two variations on this basic model of an endowment policy. ENDOWMENT Conventional ULIP .

administrative charges. Marketing and Administrative Expenses . insurer‟s profit and the investment. . Investment The premium cannot be broken down into its constituent parts : risk premium.Conventional Profit to Insurance Company . Risk Premium .

The pool of premiums collected during the year. is used to meet the claims arising during the year and the expenses. Premium income + minus Investment income Claims + Expenses equals Surplus . plus the investment income.The financial structure of a conventional endowment plan is very similar to that of a pure term insurance plan. What remains behind is the surplus.

Premium income + Investment income minus Claims + Expenses Surplus equals To whom does this surplus belong ? The endowment insurance plan has two stakeholders :   the shareholders company the policyholders of the insurance .

How is the surplus calculated ? The calculation of surplus in an endowment plan is not as simple as Premium income + Investment income minus Claims + Expenses Surplus equals Surplus is a result of an actuarial valuation of assets and liabilities of the insurer. .

Actuarial Valuation Increase in expected claims + Premium income + Investment income minus Claims + Expenses equals Surplus .

2 3 .How does an ULIP differ conventional endowment policy ? from a 1 You can analyse the difference between an ULIP and a conventional endowment policy at three levels.

the ULIP is more flexible.1 2 3 The superficial difference is the fact that while a conventional endowment policy has rigid regulations governing the investment of its fund. .  In an ULIP a policy holder has the freedom to direct the investment component of his premium into an asset of his choice. depending on his target return and risk tolerance.  In an ULIP it is possible to invest in equity up to levels far beyond what conventional endowment policy permits.

.1 We can go a little deeper to seek a more basic difference : an ULIP is far more transparent than a conventional endowment policy. 2 3  In an ULIP you know before hand how much of your premium goes towards mortality charges. how much goes towards the expenses and how much is invested.  In an ULIP you know where your fund is invested and what is it‟s worth at any given time.

In an ULIP the “mortality charges” and „expenses” are separated from the “investment” right in the beginning. .1 We can go even deeper to seek an even more fundamental difference. the company as well as the policy holders bear the risk of any adverse variation in mortality and expenses. 2  3 In a conventional endowment policy.

Any variations in mortality and expenses. just like in a pure term insurance policy. are borne entirely by the company. and the resulting increase or decrease in claims. . the policy holder has no part in either the gain or the loss.

the SA goes on increasing as the surplus is distributed to the policyholders by way of the reversionary bonuses. . 3 1 2 4 In a conventional endowment.Let us now look at another aspect of ULIP which differentiates it from a conventional endowment.

then the SA (with accumulated bonuses) is paid at the end of the term or “maturity. this is called the claim amount.If the adverse event occurs during the term of the plan. If the term ends without any adverse event occurring. . it is called the maturity amount. then the SA (with accumulated bonuses) is paid to the policy holder.

from where the SA is drawn out if and when the adverse event occurs. It‟s value at any point of time is called the fund value. . The risk premium of all the policy holders under the plan are pooled together to constitute the risk premium pool. The risk premium goes towards the securing of the SA. and the claim amount is paid. the risk premium and the investment component are separated right from the beginning.But in an ULIP. The investment component is invested separately.

If the term ends without any adverse event occurring. In an ULIP. then the fund value is paid at the end of the term as the maturity amount. if at that point of time the fund value is more than the SA. the fund value is paid as the claim amount. That is. irrespective of what the SA is. the claim amount is the greater of the two : the SA and the fund value. if at that point of time the fund value is less than the SA.If the adverse event occurs during the term of the plan. . on the other hand. then the claim amount is paid to the policy holder. the SA is paid as the claim amount.

one of the two is paid. when the fund value is paid as the claim amount. In an ULIP. Now. then the claim amount is paid to the policy holder. the claim amount is the greater of the two : the SA and the fund value. it makes the payment entirely out of the investment corpus of the policy holder. the insurance company does not have to draw anything out from the risk premium pool to pay the claim amount. . What is important here is to note that both the SA and the fund value are not paid as claim amount.We said that if the adverse event occurs during the term of the plan.

If the insurance company does not have to draw anything out from the risk premium pool to pay the claim amount. then the insurance company does not charge a risk premium to the policy holder. .If the insurance company does not have to draw anything out from the risk premium pool to pay the claim amount. that is. if the insurance company does not carry any risk on the life of the LA. then should the insurance company charge a risk premium to the policy holder ? No. if the insurance company does not carry any risk on the life of the LA. that is.

It has to charge risk premium for only that part of SA which it needs to actually draw from the risk premium pull. but is positive. In other words. at such times the the risk that the insurance company takes on the life of the LA is less than SA. even when the fund value is less than the SA.Such a situation arises not only when the fund value exceeds the SA. . the insurance company has to draw from the risk premium pool less than the full SA. Therefore it cannot chrge risk premium for the full SA. This part of SA which it needs to actually draw from the risk premium pool is called the sum at risk.

the risk premium is charged not on the entire SA. Sum at Risk Sum at Risk Sum at Risk Sum at Risk Sum Assured Fund Value Fund Value Fund Value Fund Value .Sum at Risk = SA .Fund Value In an ULIP. but on the Sum at Risk only. therefore.