All about return on premium

The absence of a maturity value is a big deterrent to individuals buying a term plan. This is not surprising as, for many years, India has seen only investment-linked insurance products being sold to insurance buyers. The culture of receiving a maturity benefit from an insurance policy is so deep-rooted that most people find it hard to believe that if you survive a given tenure, your insurance plan would fetch you no return.

 

 

The insurance companies have, therefore, found a middle ground between a term plan and an investment-linked plan, and they call it a return of premium (RoP) term plan. The idea is simple: You pay your premium for the full policy term, and if you survive the term, you get the total premium back at the end of the policy term. No interest or bonus of any kind would be paid.

 

For example, let us assume you bought a Rs 20 lakh insurance cover for 30 years at a premium of Rs 14,000 a year. If nothing happens to you during the policy term, you get Rs 4.2 lakh (Rs 14,000 x 30 years) at the end of the 30th year.

 

Unlike in a normal term plan, the premium paying term could be different from the policy term. For example, Max Life Prem-ium Return Protection plan has a fixed premium paying term of 11 years, but the cover would continue for 20, 25, 30 years. Some insurers also offer single premium products as well. Obviously, in such cases where the premium paying term is less than the policy term, premium would be much higher.

 

Some insurers also give the policyholder the option to surrender the plan midway and take a lump sum surrender value. For example, if you discontinue the policy after paying the premium for three years, you get 30 per cent of the total premium paid as surrender value.

 

To sweeten the deal, insurance companies also offer various riders with these plans. These riders include premium waiver, critical illness cover, etc. The more the number of riders included the higher the premium would be.

 

 

Though the return-of-premium plan is a good way to induce individuals to buy term plans, which they otherwise would not, there is a huge opportunity cost involved in buying such products. The cost of a RoP term plan is much more than a normal term plan simply because the insurer promises to return your money back after the policy term.

 

For example, Reliance Special Term Plan (a return of premium term plan) for a Rs 50 lakh cover, 30-year plan for a 30-year-old would cost around Rs 35,000 a year. A normal term plan with similar cover would be available around Rs 14,000, that is, at 40 per cent of the cost of a RoP term plan.The RoP plan after 30 years would give a maturity benefit of Rs 10.5 lakh (Rs 35,000 x 30 years).

 

Now consider a case where an individual buys a normal term plan and invests every year the cost difference between the two — Rs 21,000 (Rs 35,000-Rs 14,000) — in a bank FD with average annual return of seven per cent over 30 years. If you fall in the 30 per cent tax bracket, the value of the money parked in bank FD would be Rs 14.22 lakh after adjusting for tax (at an effective rate of interest of 4.84 per cent).

 

If the same money is invested in an equity mutual fund (tax-free), the return would have been much more. If the fund gives only seven per cent annual return, you would amass Rs. 21,22,533 over the 30 years. At 10% rate of return, the value of the money would have been Rs. 38 lakh in 30 years.

 

Though these rates may vary from company to company, a normal term plan, nonetheless, scores over an RoP term plan when it comes to actual cost, opportunity cost and simplicity of the products.

 

 

In any insurance product, there would be  mortality charges whether the policy has a maturity benefit or not. Typically, the cost of a term plan has mortality charges, distribution cost, and taxes. In case of hybrid products such as RoP term plans or any other investment-linked products, there are other costs involved such as policy admin charges, fund management fee, etc. These make hybrid products much costlier than simple term plans.

 

A return of premium term plan, therefore, may not be an ideal insurance scheme as the buyer is incurringa large opportunity cost for a maturity benefit that would be too insignificant in the future. 

 

However, it may be suitable for those who mandatorily want some returns albeit at lower rates of return or for those who are not comfortable with investing the difference in premiums in equity or debt instruments to earn higher returns.