How to Calculate Returns on Life Insurance Policies
Insurance is a means of safeguarding yourself as well as your family and their future. As a breadwinner for your family, life insurance is an absolute must to offer protection to your family in case of any unfortunate circumstances.
Insurance however also has the added benefit of reaping returns alongside offering a cover of protection. But choosing which policy suits you best can be an extremely confusing task. This is where the life insurance calculator comes to your rescue. It enables you to see which policy provides the best returns, easing the process of comparison.
Essentially there are two types of policies. Term Plan is a type of pure insurance policy that offers no returns other than the death benefit that your family receives in the event of your unfortunate demise. There is another policy type that offers the option of getting your investment back as returns, depending on the type of policy opted by you. This category has mainly two types of policies:
Money back or Endowment Plans:
While both of them are pretty much the same, what distinguishes them is that Moneyback gets you part of the payments in multiple intervals while the policy is active. Endowment Plans on the other hand, provide the payment only after the maturity of the policy. Despite this difference, the life insurance calculator uses the same method to calculate the returns from both the types of plans. The premium you pay, a portion of it goes to the sum assured, a part of it is deducted for administrative charges, and the remaining is invested. This invested part is what breeds returns every year. The accumulated returns are given to you as the policy matures.
Let’s see how the life insurance calculator works for Money back or Endowment plans-
The premium that goes out of your pocket is the cash outflow, while the returns are the inflow. In this case, the inflow of cash is only after the maturity of the policy. For instance, if the duration of your endowment term plan is 20 years, and you have to pay 25,000 per annum as premium for a sum assured of 5 lakhs. Then at the end of 20 years, your cash inflow will be made out of the sum assured added to the bonus declared.
You can calculate the IRR (Internal Rate of Return) on the excel sheet, using the IRR function. Remember, the initial investment will be a negative value. Go to the last cell and write =IRR, select the data all the way from the first premium amount to the net cash inflow amount in the column. Press Enter to get the IRR value. This is the return you wish to know.
In case you have opted for a moneyback plan that has multiple cash inflows, the life insurance calculator will use the same method, except the data for cash inflow will have input. Also, the net cash inflow of the year will show the amount remaining after the deductions of the annual premium.
ULIP stands for United Linked Insurance Plan. It is the market linked insurance plan where the money you play gets invested in stocks and shares among other investment products. It is thus a combination of both insurance and investment. ULIPs also offer the advantage of taking your money out after a period of three years. However, one does have to pay penalties if they decide to exercise that option and the fund value also gets reduced at the same time.
Let’s see how the life insurance calculator works for Ulip plans
- Access a genuine ULIP calculator online
- Enter your basic information like name, Date of Birth, mobile number, email address etc
- Next step involves providing ULIP related information like premium amount or your investment amount
- Choose the frequency of premium like monthly, quarterly, yearly etc during the policy tenure
- As per your convenience, choose the tenure you prefer for the policy. Keep in mind your long-term goals and take your decision smartly
- Choose the right investment fund option that fulfls your objectives
- Press Calculate!
ULIPs offer two types of options- either you can get the Sum Assure or the Fund Value whichever is higher on the unprecedented event of death. The other option is to get both in case of death.
Life Insurance policies offer many benefits and therefore it is important to compare different plans to ascertain which is the best for you. This is why a life insurance calculator is used. It helps you to differentiate between the payouts and other investment products available in the market as well as between different insurance plans. Here is how we compare insurance plans-
IRR (Internal Rate of Return)
The IRR is an important tool for financial analysis that helps one compare the returns from two separate cash flow streams. An important concept in the IRR is the NPV or the Net Present Value. This is the present value of all the cash flows as well as the future anticipated from any investment. The present value is always more than the future value because of several factors like the uncertainty of the interim period and the inflation in price. This inflation can result in reduced purchasing power. As a result, any future value (FV) of money has to be discounted using a certain discounting rate in order to arrive at the present value (PV) of money. The present value on the other hand does not need to be reduced.
So, PV=FV / (1+r)n
Here, ‘r’ is the discounting rate while ‘n’ is the period of discounting in years.
For instance, if a sum of 1000 is the present value at the interest rate of 10 percent per annum. The amount that you receive after the maturity period of one year is 1100. The reverse of this- the amount of 1100 one year in the future is worth the amount of 1000 today. We arrive at this value by using the discounting rate of 10 percent in order to derive the present value.
How to use IRR for any cash flow stream in a life insurance calculator?
Any premium amount that you pay is a negative cash flow during the calculation of IRR. Just like that, when you receive a payout or an amount, it represents a positive cash flow. When these cash flows are discounted at a certain rate, you end up getting the Net Present Value of the cash flow stream. The Internal Rate of Return is the discounting rate which makes the Net Present Value of a cash flow stream zero. The IRR thus depicts the rate of interest at which the amount of cash you invest gets compounded in order to get you the amount at maturity.
NPV= PV of all the negative cash flows + PV of all the positive cash flows
Using IRR to access different insurance plans:
Let's take an example to understand better how a life insurance calculator uses IRR-
As discussed earlier, in insurance policies, the premiums paid are the negative cash flow while the payouts received by you compose the positive cash flow. For instance, if you pay an approximate amount of 10,000 as premium today. This enables you to get two payouts in the future, one of 5250 after a year and an amount of 5512 at the end of two years. The premium of 10,000 you paid becomes the negative cash flow and it will not be discounted because it is a present value. The two payouts received become the positive cash flow and have to be discounted at an IRR.
Any future premiums are bound to be discounted at the IRR and represented with a negative sign at all times. If all of this is too complicated for you, you can also use the IRR or XIRR function in the Excel sheet to calculate the Internal Rate of Return.
Using this method of life insurance calculator one can easily compare the different insurance plans available in the market using different rates of premiums and payouts in an attempt to get their IRR.
In a Nutshell
We often depend on the sellers of insurance policies to offer us some clarity amidst the confusing task of choosing the one that is perfect for us. While that is one way to go, it is always better to be self-sufficient. It will also prevent us from being misled into opting for an alternative that is not the wisest choice. Thus, we have tried to simplify the method used by a life insurance calculator to make it easier for you to understand.