Are Returns on Endowment Policies worth your time & investment?

Endowment policies are a popular insurance product for savings, especially back in the days where there weren’t many investment options, or where the other options came at a pretty hefty out-of-pocket cost. But what exactly have been the returns on endowment policies historically? And are they worth our time and investment in them?

Right off the bat, there are a few disadvantages with endowment policies as an investment vehicle. The most important of these being the long commitment period required to see any sort of returns on the investment, as the surrender value of the policy before maturity is usually quite poor compared to alternative investments. Over the long commitment period, the insurance company may revise the bonus rates downwards, reducing the returns on the policy compared to the initial illustrations. And this creates more misunderstanding about the return on endowment policies, simply because few of us can even remember what was communicated to us at the start of the policy!

The returns on endowment policies are further complicated because insurance premiums are wrapped up in the premiums paid. While the premiums on riders are quoted separately, the insurance premium itself is not easily separated for better understanding of the returns. And this tends to create the impression that endowment polices have poor returns.

Case study of two endowment policies held for more than 18 years

As luck would have it, we’ve had two endowment policies from different insurers incepted at around the same time (early 2000’s) mature recently. So let’s take a look at how the returns have been, compared both to:

• the original illustration of the returns provided;
• how the markets have performed over the past 2 decades; and
• how the returns on the insurers own participating funds have been over the past 2 decades

Endowment Policy 1 from Insurer A

The first plan was held for 18 years. For a yearly premium of $100, the projected payout was $2,605, for a gross internal rate of return (IRR) of 3.77%. However, when this policy matured, it actually paid out $2,682 per $100 annual premium paid, for an gross IRR of 4.05%. So this is a surprising instance of the actual returns outperforming the projected returns!

Endowment Policy 2 from Insurer B

The second plan was held for 21 years. For a yearly premium of $100, the projected payout was $3,982, for a gross IRR of 5.49%! Remember, this was in the days before the Monetary Authority of Singapore (MAS) mandated that insurers had to project payouts based on a 3.25% return and a 4.75% return on investments. Clearly, back in the bad old days, the insurers had a field day projecting all sorts of outlandish returns on endowment policies to their unsuspecting customers! However, upon maturity, it actually paid out only $3,118 per $100 annual premium paid, for an gross IRR of 3.46%. This follows several years where bonuses were slashed while customers watched on helplessly.

In summary, the two policies looked like this:

Actual and projected gross returns on endowment policies

	Insurer A	Insurer B
Projected payout per $100 premium	$2,605	$3,982
Actual payout per $100 premium	$2,682	$3,118
Projected IRR	3.77%	5.49%
Actual IRR	4.05%	3.46%
Term of policy	18 years	21 years

But that’s not the end of the story. We have not accounted for the built-in insurance component in these policies. While we may be content to look at the returns on a gross basis (inclusive of insurance premiums), a more accurate view needs to strip this out. This is because we have essentially paid for a service (which we were lucky not to have to use), and these premiums were not invested.

To work out the insurance premiums, we go back the the life tables for Singapore, which detail the mortality rates for Singaporeans. We use the table of 2003, being the earliest version available here. And as we have blogged here, pure life insurance tends to be overpriced for the young. Hence, after working out the actuarially fair price of life insurance, we adjusted these values upwards by 50% to reflect this over-pricing. The pure life insurance premiums are then stripped out from the yearly premiums paid. These pure life insurance premiums ranged from between $2.60 to $4.40 per $100 in premiums paid, depending on the age of the owner when the policy was incepted, and the term of the policy.

Once this is done, the net IRR for the to policies look like this:

Gross and net actual returns on endowment policies

	Insurer A	Insurer B
Gross IRR	4.05%	3.46%
Net IRR	4.50%	3.67%
Term of policy	18 years	21 years

Hence, we see that the true rate of return on endowment policies can be between 0.21% to 0.45% higher than the gross IRRs we usually project.

How did the returns of the endowment policies fare against market returns?

So we see from above that endowment policies from different insurers can have wildly different returns over similar time periods! It seems reasonable to assume that the higher the initial projections made for returns, the worst the outcome! But another way to look at returns is to compare them against alternative investments if these had existed back then.

Now, most insurers invest their participating funds in a mix of bonds and equities. This is usually in the proportion 66% in bonds, and 34% in equities. If we had instead invested our premiums in the Straits Times Index STI (ES3) and the ABF Singapore Bond Index (A35), how would that have turned out? We show this in the chart below:

Returns for the STI ETF (ES3.SI) and the ABF SG Bond Index ETF (A35.SI)

The answer is, not good. Over the period in question, the compounded returns on the 66:34 mix of Singapore bonds and equities was only 2.01% (3.49% for equities and 1.52% for bonds). Of course this includes the massive downturns in equities due to SARS in 2003, the Global Financial Crisis in 2008 and the recent Covid-19 pandemic in 2020 (which may have been missed by the shorter endowment policy). But nonetheless, it looks like the insurers did a good job in delivering the returns. But that is of course what we pay them to do, rather than doing it ourselves.

How did the returns of the endowment policies fare against the insurers’ own par fund returns?

Another way to look at the returns on the endowment policies is to compare them against the returns which the insurers make on their own par funds. Of course, this comparison is not quite so straightforward because the same insurer can have different par funds for different vintages and maturities of policies. But still, we can get some idea of how they fare in their own investment returns by looking at the overall returns across all their funds.

We looked at the returns on insurer par funds previously here, so now we extract the relevant data for the two insurers in question and update this data with the returns for 2019 as well.

Returns for insurers’ par funds 2005 – 2019

Here, we get a bit of a surprise! While Insurer A has had a lower return on its investments, they paid out more to their endowment policyholders, compared to Insurer B. Insurer B earned more in investments, but paid their endowment policyholders far less!

Another way to look at this is to look at how much of the stated par fund return actually goes to policyholders. By law, the insurer can share up to 10% of the bonuses attributable for policyholders (i.e. the 90:10 rule). There can be some further slippage between the returns the insurer gets, the profit share it gets and the return the policyholder gets, maybe because of expenses, or retention of returns in the fund (not declared). What matters is that the closer the policyholders’ returns come to the returns after profit-sharing with the insurer, the better they have been treated. We show this below:

Policyholders’ share of returns from insurers’ par fund returns

From this chart, we can see that although Insurer A did poorer with regards to their par fund returns, they ended up giving virtually all of the attributable returns after profit-sharing to the policyholders, and then some. Insurer B, in contrast has a much bigger slippage between their par fund returns, profit share, and what the policyholders eventually got. We lay this out in the table below.

Policyholders’ share of returns from insurers’ par fund returns

	Insurer A	Insurer B
Par fund return (2005-2019)	4.87%	5.21%
after deducting Profit share of 10%	4.38%	4.69%
Actual endowment policy IRR	4.50%	3.67%

So Insurer A appears to have done a pretty remarkable thing in paying out to policyholders more than they were legally supposed to, i.e. they retained a profit share less than the 10% they were entitled to.

Conclusions

Endowment policies remain one of the popular investments in Singapore, despite the availability of alternative savings and investment products, which may offer higher returns and greater liquidity, although at the cost of higher risks. Looking at the experience with endowment policies held over two decades, it appears that endowment policies are unlikely to offer returns higher than around 4% at best, which puts them in direct contention with alternatives such as bond funds, and even the CPF Special Account.

But the more important question is this: Do endowment policies have a place in our investment portfolios? The answer is probably a qualified yes. If you are starting out in your investment journey with few assets in hand, and at the lower end of the salary range, your risk tolerance may be quite low. Endowment policies, with their guaranteed returns may be a good place to start. In fact, having some part of your investments in guaranteed return products will allow you to take more risks in other areas, so instead of “buy term and invest the rest” it becomes “buy endowments and invest the rest”. Ultimately, it is a matter of product allocation and diversification, something we talk about here.

Do note, however, that endowment policies are not quite the same as whole life insurance policies. Endowment policies, with their shorter maturity periods, and lower insurance coverage, are more rightly seen as an investment product, instead of insurance products. And often, you can get higher returns over a shorter period as well!

PS: Despite the low returns on endowment policies relative to the investment returns of the life insurers’ participating funds, projected investment returns will be cut from 1 Jul 2021. The upper illustrative return of 4.75% is being reduced to 4.25%, and the lower illustrative return is being reduced from 3.25% to just 3.00%. You can read about the implications of this here.

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