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Don’t opt for return of premium term life policy

by Money Puzzle   ·  November 2, 2020   ·  

Don’t opt for return of premium term life policy

by Money Puzzle   ·  November 2, 2020   ·  

Photo by Andrea Piacquadio from Pexels

A lot has been written in our Insurance segment on why traditional plans like money-back policies and endowment life insurance policies are the worst kind of investment.

In fact, insurance should never be mixed with investment

We are not the only ones propagating this theory, but many others working in the field have also been reiterating that the best life insurance policy is a term life insurance policy. It is reasonably priced and allows you a large death benefit in case of untimely demise. 

There is however no return of premium paid; many falsely look at that as a loss. However, the right way to look at this is as a cost you pay for protecting your family’s financial future. It is not an investment

Nevertheless, human psychology doesn’t allow us to just let go of the premium paid, especially now that another option called – return of premium– has been introduced for term life insurance policies. 

It’s a lure; we say term policy is the best way to get life insurance and now they are returning premium! What better way to get insured? Unfortunately, there is a catch. Once again you are getting lured into an investment via insurance. Getting any kind of money back in insurance is technically an investment.

In all such cases, it’s always cheaper and more efficient not to opt for it. 

Here is why.

The calculation

At the very beginning, I am going to put for the numbers which simply don’t make sense. 

You are a 30-year-old woman, earning ₹15 lakh or more and looking for ₹1 crore life cover. 

  • You can get a term life insurance policy for slightly cover with any life insurance provider. We will take the example of two large private sector insurers, HDFC Life Insurance and ICICI Prudential Life Insurance. 

Both offer discounts on term life policy premium if bought online.

  • HDFC Life has a term policy that you can buy for the next 35 years at a monthly cost of ₹1195 or an annual cost of ₹13,655. The premiums paid will not be returned.
  • You have the option, in this same policy to get your premium back. However, now the premium itself increases to ₹29,339 a year. 
  • Over a period of 35 years till you turn 70 that is a difference of ₹5,48,940. 

DING – You are paying more to avail of the facility of getting your money back!

And you thought it was going to be a free lunch.

Let’s not stop here. The difference in the annual premium of the two plans is roughly ₹15,684. 

  • You can take this amount and break it up into equal monthly investment amounts of ₹1300 and invest in equity-oriented mutual funds. 
  • Let’s assume a modest 10% return over the 35-year period of the policy. 
  • Over this time your monthly ₹1300 will grow to a princely ₹50 lakh!

DING: By opting for the regular premium term policy instead of the return of premium, not only are you saving money but also earning a lot more by investing it correctly. 

  • Some policies will further entice you with a survival benefit at maturity, assuming you are alive at the end of the policy term. Even this pay out pales in comparison to the investment return you can get on your regular investment with the excess premium paid for return of premium facility.

We ran the same data with ICICI Prudential iProtect Smart and its return of premium version. The difference in annual premium for this policy, assuming a maturity age of 65 years and a policy term of 30 years, is ₹10,500 annually. Which is a difference of ₹3,15,000 over a period of 30 years. 

Use this ₹10,500 to invest ₹875 every month for the next 30 years in equity-oriented mutual funds at an assumed return of 10% a year; you will get ₹20 lakh at the end of the 30 year period. Again, this is a lot more than any return of premium or survival benefit amount that the policy will payout. 

DING: Take control of your money, separate insurance, and investment in ALL FORMS.

The conclusion

Why do insurance companies charge you so much more than you should pay? Unless you work for one, you may never know and even if you do work for one, you may not know. 

If we can figure out the most effective and efficient way to invest money for long periods or decades, it’s hard to imagine that insurance companies don’t already know this. If they do, then what stops them from at least passing on the benefit to you after deducting their charges?

Who knows, it could be to bolster profits or it could be to sustain the cost of a vast distribution network. Or it could be any other reason. 

Rather than speculating on what life insurance companies do and what motivates them, let’s focus on how you can take responsibility for your money choices. 

DING: Mixing insurance and investment is absolutely the wrong choice!

Be smart and make aware money choices, control what you can, and leave the rest up to evolution!

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