How does an endowment life insurance policy work?
When you take out an endowment life insurance policy, you pay a premium into a contract every month. This amount is divided into the following three parts:
- Cost portion: this is the money the insurance company keeps for its work. These costs are varied and often non-transparent. They include acquisition costs, administrative costs, cancellation costs or installment surcharges for monthly payments.
- Risk portion: This portion of the premium is set aside to cover the risk that is also very often covered by an endowment life insurance policy. These include, for example, death or occupational disability.
- Savings portion: The savings portion is invested by the insurance company to save capital for your retirement.
As you can see, with an endowment life insurance policy you have two products in one contract: on the one hand, coverage of a risk, and on the other hand, capital accumulation.
As a "combined product", the endowment life insurance is criticized because the mixing of two products in one contract is associated with high costs. Thus, it is significantly cheaper to take out the risk of death or occupational disability in a separate contract and use other products for saving capital.
Advantages and disadvantages of endowment life insurance
If you took out an endowment policy before 2005, payouts from it are completely tax-free if the policy has been in force for at least 12 years. If you would invest money in ETF, stocks or other securities, the profits from it are subject to the final withholding tax. This tax does not apply to endowment life insurance that was taken out before 2005 and had a term of at least 12 years.
Contracts after 2005 also qualify for tax relief. In this case, only half of your gains from it are taxed if the minimum term was again 12 years and the payout does not take place before your 62nd birthday. Otherwise, this tax benefit does not apply.
Another advantage is the guaranteed interest rate, which is why many endowment life insurance policies were sold in the past. The guaranteed interest rate is guaranteed by law and is one of three components of an insurance contract. In recent years, however, this interest rate has continued to fall.
The historical high of the guaranteed interest rate is 4%. At that time, policyholders received 4% guaranteed interest on their savings portion. Today, this is only 0.9% and there are many voices that want to abolish the guaranteed interest rate.
The background to this development is the low-interest phase. This makes it increasingly difficult for insurance companies to generate sufficient returns on their investments and to maintain the guaranteed interest rate.
The second component:
The second component of your endowment life insurance contract is the profit participation. If the insurance company has managed your money well, it distributes a portion of the surplus profits to you.
Surplus participation has also been decreasing in recent years. For one thing, insurance companies have many old policies with high guaranteed interest rates in their portfolio. Therefore, the insurance companies' profits have to be used primarily to service these contracts with guaranteed interest rates of up to 4%.
Secondly, it has become increasingly difficult for insurance companies to earn money. The reason for this is the low-interest phase already mentioned. Life insurance companies can only invest a small proportion in shares. They are required by law to invest a large part of their capital in safe government bonds.
The third component of your insurance contract is the so-called final bonus. This works similarly to the profit participation and is paid to you by the insurance company if you keep up the entire contract term.
Although this final bonus can be a good yield supplement, it is rarely paid out because most life insurance policies are terminated before expiration. In fact, only 50% of all policies last to the end because the other half of policyholders are dissatisfied or need the money elsewhere.