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Why 'Return Of Premium' Term Insurance Is A Disastrous Idea?

You are well aware of how your vehicle insurance works. If, during the year, your vehicle suffers any damage, the insurance company pays for the repairs. But, if nothing happens, you get nothing in return for the premium paid (except for the mental satisfaction that your vehicle was protected).

A normal Term Insurance Policy works on exactly the same lines. In case of any unfortunate eventuality, your nominee(s) receive the Sum Assured from the insurance company. But, if you survive the policy tenure, you get nothing in return for the premiums paid (except for the mental satisfaction that your family was protected).

Many people don't attach much value to this 'intangible' idea of 'mental satisfaction'. So, they don't like to buy such pure insurance covers, where the premiums are likely to go down the drain.

There is logic is simple — Why pay "real" money for an "unreal" benefit?

Normal term insurance policies, therefore, find very few takers.

People buy such type of plans only when forced to do so. Hence, vehicle insurance is common ONLY because it is compulsory by law. But, very few would go ahead and WILLINGLY buy a Term Plan.

To break this psychological barrier, the concept of "Return of Premium" is attached to a normal Term Insurance Policy.

This in, plain and simple terms, means that 
- Your nominee(s) will be paid the Sum Assured in the event of death
- You will be returned ALL the premiums paid in the event you survive

Wow! That's sounds great indeed.

Since you know you will get all your money back, you are more than happy to buy such a Return of Premium Term Policy.

Beware!

DON'T FALL FOR THIS HONEY TRAP!!!

And, here's the simple and straighforward reason for this WARNING.

Let's take a simple example.

Assuming you a 30-year old person, a normal 15-year Term Plan for a Sum Assured of Rs.10 lakhs, would cost you a premium of around Rs.2500 per year for 15 years.

In the event of death, your family would receive Rs.10 lakhs. If you survive, your 'mental peace' due to protection, would have cost you around Rs.37,500 over 15 years. There will be no returns in the monetary terms.

Instead, say you decide to buy a Term Plan with the option of Return of Premium.

term-plan-return-of-premium
Just say NO to the Term Policies 'with' the option of Return of Premium.

NOW, READ THIS CAREFULLY!

Typically, such plans will cost you a premium which is at least 3 times (maybe even more) than the normal premium.

Hence, your premium for the same policy terms i.e. 15 years tenure and Rs.10 lakhs sum assured, would be minimum Rs.7500 (if not more)

Now, in the event of death, your family would receive Rs.10 lakhs. But, if you survive, Rs.1,12,500 i.e. the premiums paid over the 15-year policy term, will be returned to you by the insurance company.

So far so good!

BUT, NOW CHECK OUT THESE CALCULATIONS!

Let's say you buy the normal term plan for Rs.2500 and invest the balance Rs.5000 (i.e. the extra premium for the 'Return of Premium' option) in a Bank Recurring Deposit.

Then
- the normal term plan will provide the same level of protection
- but your deposit after 15 years would be worth Rs.1,20,911 (at say 6.5% interest).

Thus, even taking a very safe investment and a very nominal rate of interest, you will end up with more money than what you would have otherwise received from the insurance company.  

By the way, suppose you invest this Rs.5000 per year in an large-cap equity fund and conservatively earn 12% p.a. returns. If that be so, you will have whooping 66% extra money i.e. Rs.1,86,399 as against Rs.1,12,500.

IMPORTANT NOTE
This difference will be more if the premium on 'return of premium' policy is more than 3 times the normal premium, as is normally the case.

At say 4 times the premium cost i.e. Rs.10,000, your recurring deposit balance (for the difference of Rs.7500) would be Rs.1,81,366 after 15 years; as against return of Rs.1,50,000 as premiums paid.

Likewise, with a large-cap equity fund, you will have whooping 86% extra money i.e. Rs.2,79,598 as against Rs.1,50,000.


Clearly, it would be our utter foolishness, if we are still lured by the so-called rosy promises of getting all our money back at maturity. I am sure we are lot smarter to see through this gimmick!

In short: DON'T BUY Term Insurance Plan WITH Return of Premium Option.

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