Why You Should Not Purchase Term Policy with Return of Premium

I have many friends in Tier-II and Tier-III cities. Whenever I meet them, we discuss old stories, school/college days etc. One day we were having discussion about our professions. When I told them that I am a financial planner, everybody started asking me about the best mutual funds to invest in.

I asked them the very first basic question- Would your family be able to survive (financially) if you are not around? Everyone said yes. We have LIC policies – was everyone`s answer.

My 2^nd question – How many of you have Term Insurance policy? You know what the reply was- Yaar, maturity pe kuch nahin milta(You do not get anything on maturity in term insurance policies). One of the friends said- I have taken a term insurance policy with return of premiums. Everyone was happy with the option and wanted to have term insurance with return of premiums.

Though people in Tier-1 cities are aware about pure vanilla term cover, situation is different in tier-II and tier-III cities. People want to get their money back. People want surety. That is the reason traditional policies, term insurance with return of premium policies are so popular there. For the same reason, I am writing this article to help people to understand how such policy work.

What do you think- Are term insurance policies with return of premium are better options?

Before calculating the benefits, let us see how term insurance policy with return of premium works?

Also Read:- Retirement Planning with Simple Retirement Calculator

Term Plan with Return of Premium

It is a term policy where the insurance company pays the sum assured if the person dies. If the person survives till maturity, all the premiums are paid back at the maturity of policy.

Does not seem to be a bad option. Security both ways, Right!

Let us take an example

Ajay is 30 years old and wants to take a term insurance plan, off course with return of premium. For a sum assured of 1 Crore and term of 30 years, Ajay will pay a premium of Rs. 25000/- per annum. Now let us check the 2 scenarios

1. Ajay dies at age 50: Nominee will get a sum assured of 1 crore
2. Ajay survives till the age of 60: Ajay will get return of premium i.e. 25000*30= Rs. 7, 50,000.

Return of premiums (ROP) term insurance plans have other benefits too

ROP policies have paid options too i.e. if you stop paying premium after 3 years, the policy will still continue but with reduced benefits. i.e if the person has paid only 5 premiums and dies in 10^th year, the sum assured would be reduced. Normally the reduced sum assured is calculated on basis of

Reduced Sum Assured = (No of premiums paid/Total No of premium) * sum assured

In the above example the reduced sum assured would be 16 Lakhs.

Surrender benefits are also available in Return of premium policies. Some companies return you the entire amount while some companies deduct the first-year premium and other charges like admin, medical charges etc.

All seems good till now. Is it so? Let us see the actual case.

Example:

In the first option, the only benefit is the payout of 1 Crore to the nominee in case of death of the policy holder before age 60. In the second option, in addition to the death benefit of 1 Crore, the premium of 24968 x 30 = 7, 49,040 will be returned in case of survival at age 60.

You can see the premium difference in both cases. In the second option, you are paying an extra of 15251 per year for 30 years.

In case of death, you will get sum assured of 1 crore in both the cases. So, no point discussing the death scenario.

Maturity Benefits

Scenario 1 – Pure Term Insurance Vs Return of Premium Policy

Value at Maturity – In case of pure term insurance, you will not get anything at maturity.

In Return of premium policy, you will get 24968*30=Rs. 7,49,040 at maturity.

Scenario 2 – Return of Premium Vs Pure Term Insurance + Mutual Funds

Value at Maturity – In case of pure term insurance, you will not get anything at maturity.

Yearly Surplus to invest -15251 (as mentioned in above table). I am assuming that you are investing 15251 per year in mutual funds for 30 years.

Time Period- 30 Years

Assumed Returns -12%, Value at maturity (Mutual Funds) – Rs. 36, 80,565.

In Return of premium policy, you will get 24968*30=Rs. 7, 49,040 at maturity.

Now, you can decide which option is better!

Surplus after 30 Years – Rs. 29, 31,525.

Do I still need to explain, which one should you buy? Pure term insurance plan with mutual funds or return of premium term plan?

A surplus of 29.31 Lakhs is after 30 years is the option for you and for everyone.

To give you a brief idea, these are some of the return of term insurance premiums products in the market, which you should not buy.

Aegon Life I Return

HDFC Life 3D Plus Return of Premium

Tata AIA iRaksha TROP

Max Life Premium Return Protection Plan