Why should you choose basic term plans over return-of-premium plans?

There is a good reason to choose a basic term insurance plan as against a return of premium (ROP) plan. Let’s take a look at it in this post to decide better before choosing to buy a life insurance plan.

Term plan is a popular investment option for a large population in India. However, many people are still more inclined towards buying Return of Premium (ROP) insurance policies like ULIPs, Endowment plans and Money Back plans.  But when it comes to cost-effective life insurance plans, nothing can beat a term plan in offering huge cover at a nominal premium.

Hence, term insurance plans are regarded as the best insurance plans and the most efficient ones among all types of life insurance policies. With a basic term life plan, one can pay a nominal premium and get decent life cover.

What are Return of Premium (ROP) plans?

People in India generally do not like the idea of purchasing a term plan without the maturity benefits. And that is the reason why insurance companies came up with the concept of term plans with return of premium, which is a new version of the term insurance. Let’s take a look how the ROP plans work as against basic term plans:

For example, let’s say two individuals plan to buy term plans. One of them goes for a basic term plan of INR 1 crore sum assured, while the other buys a Return-of-Premium Term Plan of INR 1 crore coverage.

Now, what happens if the policyholder meets with an unfortunate event that leads to his/her demise. So, in that case the nominee of both the plans receives the same amount of sum assured as death benefit. On the other hand, in case the policyholder survives the tenure of the plan, the basic term plan will not pay anything back whereas the ROP plan pays back the premiums paid over the years.

So, obviously the ROP plan sounds better for people as it allows them to get the premium back at maturity. However, it’s not that simple, especially when it comes to the annual premium. The ROP plan, which allows you maturity benefit, levy huge annual premiums on the policyholder and are way more expensive than the simple term plans.

Premium Difference between Simple Term Plans and Return of Premium plans

The premium charged in case of return of premium term plans can range between 2 to 4 times the money as compared to the basic term insurance plans.  For instance,

Suppose a 30-year non-smoking male plans to purchase a term insurance plan for INR 1 crore for a term of 30 years. He would be paying a premium of INR 11,950 per year for 30 years for a Simple Term Plan, whereas he would be paying INR 23,600 per year for 30 years in case of term insurance plan with return of premium.

At maturity, the individual receives the premium paid for 30 years back in case of the Return of Premium Plan which is INR 7.1 lakh. So, it is for sure that the difference in the premium amount cannot be ignored when it comes to planning for a term plan. Of course, the difference between maturity amounts is also something that you can’t ignore. And that is the reason why people get tempted to buy the return of premium plans so that they could get back something if they survive the plan. But, to state the fact, that is not the right approach to compare the two plans.

For instance, in the earlier example the individual buying a return of premium term plan has to pay INR 11,650 extra in a ROP as compared to the basic term insurance policy. So, you would be paying INR 7.1 lakh extra and receive the same amount at maturity after 30 years in case you survive the policy.

That’s because insurance companies pay back only the premiums paid by the insured and not the sum assured if the person survives the policy duration. Hence, you would get only the premium amount that you have paid, which is INR 7.1 lakh. However, rather than buying a term plan with return of premium, if you buy a simple term policy at nominal charges and use the remaining premium amount to invest in another plan for 30 years, you would get better returns.

So, let’s see the difference in value that you might receive if you invest the rest of the premium amount that is INR 11,650 in a different plan.

Value of the annual investment of the difference amount

So, depending on the investment option you choose, the returns would vary;

If you invest in a plan offering 7% returns for 30 years at 11600 per year, you might receive INR 11.8 lakh at maturity.

If the interest rate of the investment you choose is 8%, you might get INR 14.2 lakh at maturity. Similarly, with 9% returns, you receive INR 17.3 lakh and at 10% returns, the amount received is INR 21.1 lakh.

So, as you can see there is a huge difference if you invest the difference of amount in an investment plan rather than paying that amount towards your return of the premium plan.  Thus, buying a return of premium plan is not advised as compared to simple term plans.

Though insurance agents might influence you to buy a return-of-premium plan to get a better commission amount, it may not suit your long-term financial goals.