Term life insurance is the most efficient, and best form of life insurance. There is no doubt about that. And people are gradually realizing this.
For a very small premium, you get a very life cover.
Many are still inclined towards buying traditional LIC plans (endowment and moneyback) and ULIPs. The fact is that neither of these can beat the term plan when it comes to providing a big enough cover for a very nominal premium.
But many Indian insurance buyers don’t like the idea of ‘no maturity benefits’ of term plans. And sensing this, insurance companies introduced a new version of the term plan a few years back, named as the Return-of-Premium Term Plan. Here is how this works compared to plain term plans:
Suppose there are two friends who decide to purchase a term plan. But one decides to go for a simple term plan of ₹1 crore and the other decides to go for a Return-of-Premium Term Plan of the same coverage of ₹1 crore. Here is what happens:
· In case of the demise of the policyholder, both the simple term plan, as well as the Return-of-Premium plan, pay the same amount i.e. ₹1 crore.
· In case of survival (or maturity), as expected, the simple term plan pays back nothing. But the other Return-of-Premium plan gives back all the premiums you paid over the years.
This might sound good and in favor of the Return-of-Premium version, but hold on. There is something else too. Both plans have different annual premiums. As the Return-of-Premium term plans involve returning back all the premiums paid at maturity, they are more expensive than the plain pure term plans.
And how big is the difference in premiums between the two?
The premiums of the newer version can be 2-4 times more than those of a plain term plan. Let’s take two real examples and see the difference. As per premiums on a reputed life insurer’s website:
For a 30-year old non-smoking male, buying a ₹1 crore coverage for 30-year tenure, here are the premiums:
· Simple Term Plan - ₹11,950 annually for 30 years
· Return-of-Premium Term Plan - ₹23,600 annually for 30 years
And on maturity, you get the total premiums you paid over the 30-year period, i.e., ₹7.1 lakh back in Return-of-Premium plans.
As you can see, the difference in premiums is there and can’t be ignored. To be fair, there is a definite difference in maturity (and survival) benefits as well. But while many might be tempted to get ‘at least something back’ from the Return-of-Premium plans, that is not the right way to compare these two types of term plans.
Let’s continue with the earlier example.
The difference between the premiums of the two policies is ₹11,650. So, by paying ₹11,650 extra every year (compared to a simple term plan), you get back ₹7.1 lakh after 30 years. remember, that insurance companies only return the premiums paid and don’t give any extra interest on it.
Now what would have happened if instead of buying the Return-of-Premium plan, you just bought a simple term plan (with ₹11,950 premium) and used the difference amount of ₹11,650 to invest every year for 30 years?
How much would be the value of that annual investment of the difference amount?
The returns may vary for different investment options. So here is what you might get:
· At 7% returns, you get ₹11.8 lakh
· At 8% returns, you get ₹14.2 lakh
· At 9% returns, you get ₹17.3 lakh
· At 10% returns, you get ₹21.1 lakh
The difference is huge if you compare it with the total premium you get back from Return-of-Premium plan of ₹7.1 lakh.
And this is the reason why buying a Return-of-Premium plan just does not make any financial sense at all. The calculations above prove that very clearly. But insurance agents, in order to maximize their commission income, psychologically push for these plans because many of us Indians are still stuck with the traditional ‘get something back or money back’ mentality.
These plans are often marketed as ‘costing nothing since one gets back the premiums’ but as you have seen, that’s not the case at all. In fact, these can turn out to be very costly in the long term.
So, all said and done, just purchase a plain vanilla term plan and invest the difference amount (over the Return-of-Premium plan). That’s all. Don’t buy Return-of-Premium term plans.
Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.
