Comparison between Term Insurance Policy and Traditional Insurance Policy

by Gopal Gidwani on December 27, 2009 · 16 comments

in Insurance,Uncategorized

Buying Insurance over Other Investments for Returns: Opportunity Cost or Opportunity Lost 

Introduction
It’s March, the tax planning season is at its peak and Ajay (person earning 6 Lakhs pa working in an MNC) has started his yearly ritual of scouting for investments for saving income tax. Ajay tells his financial planner Pankaj that he is looking for an insurance plan which is very low on risks and will give good returns. Pankaj is a smart financial planner and tosses a question to Ajay which puzzles him. Pankaj asks Ajay “Do you buy a general insurance product for your car which gives you car insurance plus returns at the end of the year?” Ajay says “Car insurance plans are meant for protection against risks like accidents and not for returns.” On hearing Ajay’s answer, Pankaj smiles and says “Bingo, you are absolutely right. Don’t you think the same applies to life insurance also? Returns should be best left to investment products and not insurance. Life insurance should be bought only to cover the risk of loss of life and remaining surplus money should be routed through investment products for superior returns. A person should not mix insurance and returns.”

Term Policies V/s Investment Policies
Like Ajay lot of other people mix up insurance and investments. Insurance should be bought only for protection and for this Term Insurance Plans are the best. But lot of people feel that if they pay the premium for 15, 20 or 30 years for a term policy and survive the entire tenure of the policy without getting any returns on maturity, the insurance company has cheated them. It is this feeling of being cheated which makes term insurance policies unpopular among people. Lot of people get lured by returns promised by insurance companies during the tenure of the policy or on maturity, to go for return of premium policies or money back policies or endowment policies or whole life policies.
But the big question to be asked is, are investment policies worth going for over pure term policies???

Analysis of Return of Premium Policies and Term Insurance Policies + Investments Combo
Let us consider a pure term insurance policy and a return of premium policy of the same life insurance company.
Pure Term Policy: For a 35 year old person for a cover of Rs 10 Lakhs for 20 years for a Pure Term Policy, the company charges an annual premium of Rs 3500 per annum. In this policy the benefit amount of Rs 10 Lakhs will be paid only on death of the life insured. If the life insured survives the entire tenure of the policy then on maturity the life insured doesn’t get anything.
Return of Premium Policy (ROP): For the same 35 year old person for a cover of Rs 10 Lakhs for 20 years for a Return of Premium Policy, the same company charges a premium of Rs 14000 per annum. This policy has a death benefit as well as a maturity benefit component. On the death of the policy holder the death benefit (Rs 10 Lakhs) is paid to the nominee. If the policy holder survives the tenure of the policy then all the premiums paid over the tenure of the policy (20 years) are returned back to the policy holder. So the maturity benefit amount in this case will be
Rs 14000 (premium per year) * 20 (tenure of the policy) = Rs 2,80,000.

Comparison of Returns:
Please note that the features of both the policies that we have chosen for comparison are same.

  • Both policies are for a 35 year old person.
  • Both policies are for tenure of 20 years.
  • Both the policies are for a sum assured of 10 Lakhs

The only difference is one policy doesn’t pay anything on maturity and the other policy returns all the premiums on maturity if the life insured survives.
Now begins the analysis part. Our detailed analysis of the 2 policies throws up the following observations. Read on you will be surprised …………..
The difference in premiums of the 2 policies is huge.
Premium for Term Policy (Rs 3500) – Premium of ROP Policy (Rs 14000) is Rs 10,500 per year.
If this difference of premium between the 2 policies of Rs 10,500 per year is invested in a Public Provident Fund (PPF) Account which guarantees 8% return for 20 years the maturity value will be Rs 5,18,940.
If the person is willing to take some risk and invests the same Rs 10,500 per year (difference of premium between the 2 policies) in an Equity Linked Saving Scheme (ELSS) for 20 years and the investment earns 12% return, then the maturity value will be Rs 8,47,336.
If the person is willing to take some risk and invests the same Rs 10,500 per year (difference of premium between the 2 policies) in an Equity Linked Saving Scheme (ELSS) for 20 years and the investment earns 15% return, then the maturity value will be Rs 12,37,006.
The maturity benefit in case of Return of Premium policy will be only INR 2,80,000 (sum of all the premiums paid over a period of 20 years. 14000 * 20 = INR 2,80,000).
So now let us analyse the difference in the 2 policies.

Sr. NoName of the policyInvestmentDeath BenefitMaturity Benefit
1Return of Premium PolicyRs 14000 per year premiumRs 10 LakhsRs 2,80,000
 Total Investment in 20 yearsRs 2,80,000Percent return on maturity0%
     
2Without Return of Premium PolicyRs 3500 per year premiumRs 10 Lakhs0
  Rs 10500 per year in PPF (8% returns)0Rs 5,18,940
 Total Investment in 20 yearsRs 2,80,000Percent return on maturity85.33%
     
3Without Return of Premium PolicyRs 3500 per year premiumRs 10 Lakhs0
  Rs 10500 per year in ELSS @ 12% return0Rs 8,47,336
 Total Investment in 20 yearsRs 2,80,000Percent return on maturity202.62%
     
4Without Return of Premium PolicyRs 3500 per year premiumRs 10 Lakhs0
  Rs 10500 per year in ELSS @ 15% return0Rs 12,37,006
 Total Investment in 20 yearsRs 2,80,000Percent return on maturity341.78%
     

So on investing Rs 14,000 per year for 20 years in a Return of Premium Policy, the total maturity benefit that you will get is only the sum of premiums paid for a period of 20 years which is 14,000 * 20 = Rs 2,80,000.
But if you separate out investment from insurance and invest Rs 3500 per year in a Pure Term Insurance Policy and the remaining amount of Rs 10,500 is invested separately the returns are much higher.
Even if the remaining amount of Rs 10,500 is invested in PPF which guarantees 8% the maturity amount in 20 years will be Rs 5,18,940 (85.33% higher returns than Return of Premium Policy maturity benefit amount of Rs 2,80,000).
If the money is invested in ELSS at 12% return the maturity amount of Rs 8,47,336 is 202.62% higher that the insurance return of just Rs 2,80,000.
If the money is invested in ELSS at 15% return the maturity amount of Rs 12,37,006 is 341.78% higher that the insurance return of just Rs 2,80,000.

Conclusion
So it is very clearly evident from the above comparison that ROP plans which promise returns are way too expensive compared to pure term insurance plans. Investors should opt for insurance only for pure risk cover and invest the remaining investible surplus amount into other investment products instead of insurance.
Individuals should not make the mistake of mixing insurance and investments just for the lure of small returns. In the process of doing so you are foregoing a huge opportunity of investing your surplus money in alternate investments which can earn you substantially higher returns. It is an opportunity cost or I should say ‘Opportunity Lost’ in more appropriate words. Also don’t treat the money paid for pure term insurance premium as an expense. View it as an investment to protect your future monthly income or protect your family from financial problems in case something unfortunate happens to you.

The Chart shown below will make it even easier for you to understand the difference in returns given by different investment products.


Please do let us know your comments on the article at gopal_gidwani@yahoo.com

{ 16 comments… read them below or add one }

Marshal September 14, 2010 at 9:27 am

indeed a very well written article.
thanks for sharing!

Reply

Gopal Gidwani September 14, 2010 at 9:56 am

Hello Marshal,
Thank You very much for your compliment …………. 🙂

Reply

Manish Mundada September 16, 2010 at 12:34 pm

Hi,
I read the article on term insurance & rop insurance. I am interested in buying term insurance plan for mysel. I am 32 years old and want to know what is the highest term i can get for term insurance. As per my knowledge it is 30years. Going by 30years as maximum term my plicy will expire at my age of 62years. What is the option for me if i need insurance for additional period. I hope you give me your valuable suggestion.

Reply

Gopal Gidwani September 16, 2010 at 1:17 pm

Hello Mr. Manish,
As far as I also know, you are right in saying that term policies are issued for not more than 30 years by most of the company. If some company is making exception to this rule in some plan then I am not aware of that. One suggestion to your problem that I can suggest is after 13 years i.e is when you are 45 years old you buy another term policy for another 30 years so that you will be covered till the age of 75 years. I say till 75 Years is because most of the companies have a maximum age at maturity clause for Term Plans which in case of most companies the upper limit is 75 Years. So this is one suggestion that I can think of going for another policy some years down the line.

Reply

Avinash Borse November 18, 2010 at 2:16 am

Dear Mr Manish,

Term insurance’s are taken basically for two reasons,
1. If the sole breadearner of a family dies suddenly, then to save the family from financial crisis & long term commitements (Such as child educaion & loans).
2. To ensure that monthly expenses of family are taken careoff for a sufficient amount of time.

for example, if Mr X is earning Rs 6 Lakh per annum , has a family of one child & wife (one obviously 🙂 ). While the monthly expenses are Rs 15000 (We can assume that balance amount is safely invested ). Then due to some GOD forsaken event if Mr X dies, his family needs money not only to take care of there monthly expenses but also his child’s future education also. Assuming there is no loan taken by Mr X as yet (Which is unlikely, hence take the laon amount also into account.)

In money terms we can calculate it , thus on death of Mr X ,Mrs X should recieve an amount which when kept in Bank FD (or PPF to be on safer side) will give her monthly Rs 15000 & after some years help her with Childs higher education (say at the age of 20).

Now here comes reply to your question Mr Manish, this all is true untill you retire &/ OR your childern settle down. That would be approxiamtely at the age of 50-55-60.After that the requirement of term insurance is zero & health insurance is more.Hence term insurance are not given for more than 35 years. I m sure GOpal would agree.

Hence to conclude i would say that you dont require term insuarnce after you become 62 , Please invest in health insurance for the same. I know the reply is late but maybe a few people will benefit along with you.Hope it helps.

Regards,
Avinash

Reply

Gopal Gidwani November 18, 2010 at 9:01 am

Hi Avinash,
Thanks for the detailed explanation. What you have mentioned is correct. But please note that as on today he is 32 years old and not 62 years old. So as on today he needs both term insurance as well as health insurance……… 🙂

Reply

Avinash November 18, 2010 at 12:04 pm

@Gopal, yes i agree with you!

Reply

Manish September 18, 2010 at 1:38 pm

Thank you sir for your valuable reply & guidance

Reply

Manoj April 8, 2011 at 12:44 pm

Hi Gopal,
When I contacted a agent wahat they told for 14,000 * 20 = Rs 2,80,000 (total) we paid, with bouns the company will reutn which will be around 5L.
I am not sure about the agents words.Kindly guide us on thsi.
if My Sum assured is 5L , I am paying 25K for 20 yrs.
what will be the survival amount I will get , itis 5L or 5L+Bounus (=10L).

Although I fully agree with your sugestation TermInsurance+Investment.
and I am doing like that, kindly tell whether we will get some bonus or not ?
Thanks
Manoj

Reply

Gopal Gidwani April 9, 2011 at 8:59 am

Hi Manoj,
If you are paying 25K for 20 years (Total 5 Lacs), then the survival amount that you will get will definitely be more than 5 Lacs. Again this also depends on the plan terms and conditions. If its a return of premium plan then you will get only 5 lakhs. If it is a with profits plan then whether the total amount that you will get will be 10 Lacs or more, well I cannot comment on that. Also the agent cannot guarantee this amount unless untill the company gives it in writing. My suggestion to you will be take insurance only for protection i.e. Term Insurance. For returns go for investments in mutual funds. For any more details or clarifications you can write to me directly at gopal_gidwani@yahoo.com

Reply

aditya December 11, 2011 at 4:44 am

i want to purchase 50 lac term insurance but i want have any income proof i.e. It return etc. for office. Is it possible through online

Reply

Gopal Gidwani December 14, 2011 at 4:35 am

Hello Aditya,

Beyond a certain sum insured cover all companies will ask for income proof documents. This sum insured limit for income proof documents may vary from company to company. So I suggest you get in touch with the customer care of the company from whom you plan to buy insurance

Reply

prashant October 28, 2012 at 9:19 am

hi ,sir yr cincepts are very in portent & its true.my income 7.00 lack per year so pls say hoe mant amount of all insurance required?

Reply

sunil koshal March 16, 2013 at 5:30 pm

Very nice written & compared between both the policies. Thanks for the useful information.

Reply

Dharam vir May 12, 2013 at 11:45 am

Very nice written & compared between both the policies. Thanks for the useful information.

Reply

brijendra December 3, 2013 at 4:44 pm

very well explained, excellent!

Reply

Leave a Comment

Previous post:

Next post: