Return of Premium - Is it really attractive?

In a simple term insurance policy, the sum assured is payable if the insured dies within the specified term. If the insured outlives the term of the insurance policy, he/she gets nothing. In other words, there is no maturity value. So, what happens to the premiums paid for all those years?

The premium you pay for a term insurance plan is considered as pure cost. No component of the premium goes towards savings or investment. This is why you don't get anything at maturity. This reason is significant enough to many people to make them averse to this type of insurance plan. They think they are buying a product they will never need anyway; therefore the premiums they pay is wasteful expenses for no monetary gain in return.

Insurance companies have come up with return of premium plans (ROP) to satisfy this aspect for the customer. ROP is basically a term insurance plan that returns the sum of all paid premiums to the insured on surviving the term of the policy. Just one note of caution, though - the insured HAS to pay every premium till the end of the tenure to qualify for the return of premium.

All that is fine, but do insurance companies really add value for the customer selling this product?

Take a look at the figures given below. These are the premium quotes for pure term insurance plans as well as ROP from a well-known insurance company in India.

Table - 1

As it is made clear above, for the same sum insured, the difference between premium paid for the pure term plan and the ROP keeps increasing with decreasing tenure.

Now look at these figures here below. It gives you the returns on the extra premium amount paid towards the ROP, if you had invested it in any other investment product. I will take three scenarios into consideration, with rates of return at 6%. A post-tax return of 6% is extremely conservative figures by today's economic environment. Take a look at the opportunity cost associated with "investment" in ROP insurance plans.

Table - 2

We only invest the extra amount in premium paid toward the ROP, for the same tenure as the pure term insurance plan. That is, your insurance cover remains the same, but now you actually have an investment component. For instance, if you invest the Rs. 7604 (the extra premium on the 30 year ROP plan) at 6% return, your corpus at the end of 30 years will be Rs. 6,37,228. That same money would have given you Rs. 4,37,100 via the ROP. The surplus you get by investing yourself is Rs. 200128, i.e. Rs. 6,37,228 - Rs. 4,37,100. Obviously, this difference keeps growing at higher rates of return.

The reason why ROP plans are expensive is the same as it is for endowment and money-back plans. To return your premium money to you at the end of the term, the insurer invests a portion of your premium paid to get returns. These returns allow them to factor in expenses such as sales and distribution charges, and administration charges. Furthermore, your high premiums subsidize all these expenses. In return, the insurer only pays back what you have paid them, not a paisa more. You earn no interest, there is no adjustment for inflation, and there is definitely no rate of return as there would be in an investment plan. Therefore, I think as a prudent investor, you should not mix your insurance with your savings needs but buy it as a tool only for protection. Take a pure term insurance plan rather than the ROP policy. Invest the differential premium you would have paid for the ROP in proper investment products, giving you a good rate of return.