Colin posted the following comment on the Suggest a Topic page yesterday:

I have a real tough time to measure the current value of insurance-linked products that provide payback after the 20-25 year period. Is there a way to do this easily? How should i evaluate whether its worth continuing with a policy? Or just putting money to better use somewhere else.

I am removing the insurance element (which is totally incorrect) from the equation but seems to be the only way to measure current worth. I could assume that i take a term policy perhaps to nullify this?

I know that this is a very big issue for a large number of retail investors whether they know it or not. I say that because Colin is actually in the minority in the sense that he is aware of the fact that he doesn’t know how to calculate the return of an insurance policy. The vast majority of people who own insurance policies don’t know how to calculate the returns, or if they know the mechanics of it, are not aware of the actual numbers they should use, and that is a bigger issue than the calculation itself.

**How do you calculate the return on an insurance policy?**

At very basic level, there are two numbers you have which are how much premium you pay every year, and what is the final amount you are expected to get. You use these two numbers to get the rate of return on your investment.

This is very simple if you don’t want to understand the maths behind this (which you probably don’t need either). Go to this annuity calculator, and click on “Rate”. After that enter the values as follows:

**Total:**This is the number you expect to get at the time of maturity.**Annual Amount:**The premium you pay every year.**Years:**The duration of the policy.

The system will calculate a rate of return for you after you enter these three values and this is the rate of return of your insurance policy, and if you are entering actual numbers from your policy, I would expect them to be in the mid to lower single digit range because that is generally what most insurance policies return.

**Which numbers to use in the return calculation of your insurance policy?**

This is often the harder part where the brochures and tables that you are shown often have little stars on them with subtle disclaimers that confuse the issue and make it hard to decide which numbers to use.

Every insurance policy that provides returns will either have a guaranteed and variable return, or just variable return or just guaranteed return.

If you just have guaranteed return then use that to see how much is the rate of return.

If you have only variable or a mix of variable and guaranteed then carefully go through the documents to ascertain where the distinction is and you will have to input one or more numbers to account for the assumptions they are making at various return points, and see what the policy is likely to net you in different projected scenarios. Even then, please appreciate that these are projections and may not come to realize at all if the insurance company doesn’t make as much money as they hoped they’d make.

This is definitely the harder part of calculating returns and requires some judgment calls and also the understanding that all you have is assumptions and there is no guarantee that any of this may come to pass.

**How to measure the returns against a term plan?**

Once you have calculated returns or have some general idea of what those returns might be, go to the website of any life insurance company and get an estimate of what an equivalent pure term plan will cost you. Now, deduct that amount from your premium and see how much money you save, and if you invested that in a simple bank fixed deposit how much money you’d make. In most cases, you will find that this combination is better than whatever policy you currently own.

If you have insurance policies, and have never done this exercise then I’d highly recommend doing it and getting a sense of how much you are paying for the insurance, and whether you can substitute that with a term plan and the remaining money in a fixed deposit or a mutual fund.

Use IRR / XIRR function in Excel.

The problem to me is far more complex. For a given LIC policy, i have a SA amount that is provided as part of the policy. Applying the above, i will not have any returns (or marginal at the most). There is such a varied layering of bonuses (which is known each year) that contributes to the returns. Again, the bonus is paid at the end and so has little value today.

Ideally, this will need a calculator that can incorporate the likely bonus’ that will accrue till maturity and from that calculate the present value.

In your case you can use the IRR formula and calculate the return as PP suggests above. That is not as easy as what the post describes but I guess that’s the only way to go for you.

Google how to use XIRR function in Excel. It allows you to put dates along with inflow and outflow of payments, and provides an overall rate of return – makes life easy..

Return on an insurance policy? Isn’t that like an oxymoron or something?

It is and in my opinion you should never buy insurance for returns, but there are people who have these policies, and need to calculate the returns somehow.

Nice