Money mistakes: Opting for return of premium option in term plan

The biggest apprehension to buy pure term plan, which I have observed in clients, that premium will not be returned in case of policyholder survives the policy term.

Insurance companies understand how human mind works, so they have come with an innovative idea. A new option, return of premium option. Insurance company will return the cumulative premium paid by policyholders, who have survived the policy term.

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With this option, the sales pitch becomes very powerful, if you survive, we (insurance co.) will return all the premium and if you don’t we will give the Sum Insured to the nominee.

For a non-finance person, or for anyone, who is not going in details, it looks like a difficult to reject offer.

Should you opt?

Now let us understand why this option doesn’t make sense.

Let’s now consider, a hypothetical case, for male person “Amit Kumar” born on 01st Jan’1985 and who is not a tobacco user. Let’s calculate the premium from one of the leading private sector life insurance company for sum insured of ₹ 1 Crore, for policy term of 39 years and yearly premium payment term of 39 years. Premium comes to be ₹ 22,157.

This is a pure term plan, if policyholder survives the policy term, he will not get anything.

Insurance agent proposed to opt for return of premium option, revised premium INR 42670.

In return of premium option if the policyholder survives, life insurance company will payback, 15,92,487. Amit is so happy, that he can buy a term insurance and all his premium will be returned back.

15,92,487 = 40833 (basic premium, exclusive of GST) X 39 (premium paying term)

Let’s now analyze both the option, pure term plan as well as return of premium option.
Extra amount payable, to opt for return of premium option is ₹ 41,752 minus ₹ 22,157. It comes out to be ₹ 19,595.

Let’s try to find out at what rate of interest, ₹ 19,595 invested annually will become ₹ 15.92 lakhs. We will use Rate Function on excel or you can use online financial calculator for it.

It comes out to be return of 3.38%. I am sure, all of you are wise enough to generate much more returns than this.