Term Life Insurance: Why should you not buy a return-of-premium option?

Life insurers are smart and savvy when it comes to understanding the mindset of Indians. While a majority of Indians still opt for traditional endowment-type life insurance, there is a growing section of the population which understands why purchasing plain-term life insurance is the best option.

But there are some cost-conscious Indians who still can’t digest the fact that on maturity (and survival), the term plans don’t pay back anything!

To cater to such people, life insurers smartly launched the ‘Return-Of-Premium’ option for term plans. That is, this term plan has some survival benefits.

How is this different from the plain simple term plan? 

In case of the death of the policyholder during the policy tenure, both the simple term plan and the return-of-premium term plan pay the same amount. But in case of survival is where the difference lies. Simple term plan will pay nothing on maturity/survival. But the return-of-premium plan will return back all the premiums paid over the years.

This sounds attractive. Isn’t it?

It does, but there is a hidden piece of information here. Let me unhide it - the premium for Return-of-Premium (ROP) plan is higher than that of the simple term plan.

And this is exactly what makes these ROP options avoidable.

I will explain this with a real example.

Suppose a 35-year-old, male wishes to purchase a term life cover of ₹1 crore for a 30-year tenure. I checked the premiums for various options on one of the life insurance company’s websites (HDFC Life Insurance – chosen as an illustrative example and not as a recommendation). Here is what was found -

• Plain Term Plan: ₹18,934 is the yearly premium for 30 years
• Return-of-Premium Term Plan: ₹47,712 is the yearly premium for 30 years

The difference in the premium for both is ₹28,778 – which is equal to almost one and a half year’s premium for the simple term plan.

And remember that both plans pay the same ₹1 crore in case of eventuality.

The only difference is that in the case of survival, the simple term plan will not pay anything. But the return-of-premium version will give back all the premiums you paid over the past 30 years (i.e. 30 x ₹47,712 = ₹14.3 lakh). Do note that it just returns the premium without any returns/interest.

If you still feel that in the case of the return-of-premium plan, you are at least getting something back on maturity (even though premiums are higher), then here is the real difference.

The difference between the premiums of the two policies is ₹28,778 (calculated as = ₹47,712 - ₹18,934).

Now what would happen if instead of going for the return-of-premium option, the person chooses to go with the simple term plan (with ₹18,934 annual premium) and invests the difference amount of ₹28,778 each year for 30 years?

Can you guess how much would be the value of this investment if done regularly for 30 years?

Depending on the return assumption (let’s say 7% to 10%), the value of investment will range from ₹29 lakh to ₹52 lakh!

Compare this with the other option where the return-of-premium option just ‘returns’ back your ₹14.3 lakh premium it collected over the years without any capital appreciation.

Now you see why it doesn’t make any sense to go for this return-of-premium option.

So, it’s best to just purchase a simple term plan and then, invest the difference amount (in premium over the return-of-premium plan’s premium) elsewhere in PPF, equity funds, etc. You will easily get a much higher amount on maturity than what is being returned to you by the insurers under the Return-of-Premium plans.

This is purely based on mathematics. But if you were to ask the insurers or their agents which option to choose, they will surely push you towards the return of premium plans using marketing gimmicks of how it is like having ‘free insurance’ as it returns back all the premiums paid over the years. But they will never tell you about the other scenario where if you invest the premium differential amount elsewhere, there is absolutely no case to go for these plans.

To be fair, these plans are still better than popular and traditional LIC-type endowment and money back plans. It is just that when compared to the plain term plans, there isn’t much of a case for these plans.

Dev Ashish is a Sebi-registered investment adviser and the founder of Stable Investor.