Friday, 12 August 2016

Why Not To Purchase Term Insurance With A Return Of Premium Option?

One of the most common and purest forms of life insurance is Term Insurance, which is broadly available in the market. The term insurance plan is a scheme to cover life of a person and get an assured amount to nominee in case if any unforeseen even happens but before purchasing any kind of Insurance you should know how much insurance do you need. The premiums of Term Insurance are very less as compared to that of ULIP or an endowment policy. You can get your life secure for a cover of Rs 1 crore with a mere premium Rs 7000(It depends on your age,policy term etc).



However, the sum assured and the premiums of the scheme may differ from one insurer to another. With the help of term insurance plan you can invest your surplus in other investment class for wealth creation in long term.

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You can select Policy Term for a period of 30-40 years depending on your age but i would suggest you should have term insurance policy only up to 60 years

Once the policy is matured then at the time of maturity of the policy, the insurer gives back the entire premium paid by the policyholder in Term Insurance with Return of Premium Option. But TROP gives very small internal rate of return (IRR) and you get the money in case if you survive the opted policy term.


This will be complicated for you to understand without the help of the example, let us go step by step in order to understand Why TROP is not useful


Following figure illustrates some of the renowned companies offering term insurance plan with return of premium. Different companies have different premium and plans.


There is huge difference of premium you pay for term insurance plan with a return of premium(TROP) and the pure term insurance.
Let us understand by considering an example 
Mr. Rajesh Singh,30 years old wanted to purchase a Term Insurance for 30 Year Term i.e thinking he would retire at 60 years. The insurance agent (agent can be offline or policy bazaar or anyone) gave him two options of the term insurance plan with a return of premium and other one of without the return of premium. 
Mr. Rajesh inquired about the difference between both and he found the difference below 




The sum assured of life is Rs 1 Crore with the annual premium of Rs 25000 in the case of term insurance plan with a return of premium and annual premium of Rs 10000 in case of term insurance plan without return of premium. 
Death benefits remains Rs 1 Crore in both the policy types. However, the maturity benefits will not remain same in both cases. 
If Mr Singh survives the policy term then he would get a his premium back of Rs 7.5 Lakhs (Rs 25000*30 years), whereas in case of without return of premium will give no benefit to the policyholder. 

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Mr. Singh after understanding the difference between both the policies was attracted towards the Term insurance plan with a return of premium. The agent also suggested him the policy with return of premium (As they always do for a need of higher commission and or may be with lack of knowledge)

Nevertheless, consider the same situation and have a look from other perspective. Say that Mr. Singh does not pay the rest of the Rs 15000 (Rs 25000-Rs 10000) and goes for the option of Pure Term insurance.Assuming Mr Singh being a risk averse person could invest that Rs 15000 annually in PPF account considering a rate of interest 8.10% percent for the 30 years. He would have got Rs 18,85,923 instead of Rs 7,50,000

(18,85,923= 15000*(1+8/100)^30), which is far more than the maturity benefit in TROP. He can earn more Rs 11,35,923 (Rs18,85,923-Rs7,50,000) by investing in PPF account.

Mr. Rajesh Singh can earn more as compare to this policy, when he will invest in the PPF account. However, we know that the safest and best way to generate the tax-free returns is by investing in the PPF accounts. 


Let us take a different scenarios where Mr. Rajesh Singh opted for another option like investing the rest of the amount in the diversified equity mutual fund through SIP. If he will deposit sum of Rs 15,000 per annum for 30 years at the compound annual growth rate of 12 percent then he will fetch the amount of Rs 40,69,389, which is really a big amount by the formula shown below. 


The profit earned by Mr. Rajesh Singh at the time of the maturity was Rs 33,19,389 (Rs 40,69,389- Rs 7,50,000).
 

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Now let us see the difference between PPF account and diversified equity mutual fund through SIP with the help of the table shown below 

In case if you are purchasing a term insurance with return of premium please keep in mind TROP is a TRAP

I hope i have addressed everything pertaining to Term Insurance with returns of premium, in case if you have any doubts or clarifications do let me know your thoughts via comments

About the author
Vipul is an MBA in Finance, PMP Certfied Professional and into software sales for Asset Management Companies, Pension Fund and Stock Brokers from last 16 years.

Vipul believes that the amount of financial information flowing our way is probably 10 times more than what it used to be 15 to 20 years back due to the advent of newer forms of communication.
All this information is creating an information overload in the minds of individuals resulting in analysis paralysis and he helps them select the right decision while creating a Goal based financial plan.
In case if you need a Financial Plan please connect to him on vipuls1979@gmail.com


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Disclaimer  :-

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