At present, many short tenure (3 years) endowment plans are way more attractive than most savings accounts for sitting cash. The appeal is intensified because it also offers some level of death coverage as well as guaranteeing your capital. The question is how do these companies that offer such plans ensure profitability? This question itself is quite telling because there must be an almost guaranteed strategy behind this short term “loan” from policyholders. In this post, I will try to use my knowledge in investments to propose possible methods that these companies use to ensure profitability. Also, we will be addressing why these policies have limited tranches up for grabs.
Why are insurance companies more generous than banks?
As an investor, I can say with a certain confidence that 2% a year is actually not difficult to achieve even for the laziest of investors. This is because decent companies that are paying dividends are usually paying more than 2% already and we have to understand that insurance companies have fund managers working behind the scenes to provide support and expertise. Such returns are actually more achievable in the current climate as 3 years is the expected timeline for many companies to recover from the pandemic. In short, this offering is not only easy to achieve profitability but also beneficial for the business over time from additional coverage and policies purchased by the batch of “new blood”.
What is the purpose of offering such policies to the general public?
Insurance companies probably have a different set of restrictions when managing capital as they are not banks. This gives them the benefit of adjusting the rate of returns for their policies so long as their funds can generate sufficient returns for the capital vested by policyholders. The interesting part of the equation is the determination of the rate of around 1.8-2% and the theory in my mind is that the intention of such policies is probably not to raise a huge amount of capital but rather to use these policies as teasers for their advisors to gain access to the general public. Additionally, these finance firms are also cautious to not cannibalize on depositors’ assets which will further implicate struggling banks.
3 years tenure buys enough time for companies to plan ahead
Unlike bank accounts that usually offer returns annually, these 3 year-long policies actually allow companies to try and secure the required returns ahead of time. This is achievable through market volatility of the companies they invest in, in addition to the recovery of the market in general as mentioned earlier. As such, these companies are able to roll out these policies with certainty that they are able to pay out around 106% for risk-averse savers after maturity. In short, the current low-interest-rate environment has definitely created opportunities for savers to part a small part of their cash for returns higher than their current savings accounts.
Closing Thoughts
Special thanks to the emails sent to me with regard to the appeal of these endowment plans. The emphasis I am trying to make is that savers should start questioning why companies do what they do because no company will sell policies that do not make money. Surely, there are “experts” who are tasked to manage these funds but we should also question why this rate is set at such a level. The short answer is that such rates are actually easier to achieve especially when given 3 years to achieve 5-6% when companies are already paying 3-5% per annum.
