Life Insurance can be broadly classified into 2 categories-
PURE RISK (Term Plan) and INVESTMENT + INSURANCE (Endowment Plans, Moneyback Plans, Whole Life Plans, ULIPs and etc).
There is a high possibility that you might have heard your parents or relatives discussing the latter ones rather than a term plan and this is mainly because we have been brought up in a financial environment where a term plan is seen as a taboo and a very bad financial investment.
However, As Individuals are becoming Financially aware, they have started to realize the importance of having a term plan in place but now they are often confronted with another important question
“Does it make sense to opt for a Pure Term Plan or Return of Premium Term Plan (TROP)?”
In today's blog, we will be answering this question, however before we begin let us understand the reason for TROPs coming into existence.
Return of Term Plans - TROPs were launched by Insurance companies when they realized that the Individuals would often hesitate to buy Pure Term Plans as there was no maturity benefit if he/she survived the term, thus to make the product more appealing and attractive TROPs were launched by the Insurance companies.
TROP plans can be classified as a mix of Term Plan and Investment Option
Now the Insurance companies could proudly say
“If you survive till maturity then we will give all your premiums back to you”
and certainly getting the premium amounts back on survival rather seems comforting to the mind and makes us think that it is a great product, however, if you would sit down to inspect it in detail you might want to rethink about buying the product because all that glitters is not gold.
I read a very interesting statistic on Policy Bazaar stating that 23% of the customers had opted for TROP plans and these are the same people who fail to realize the time value of money.
So let us understand with the help of an example whether TROPs make some sense or not (Financially)?
Case Studies are the best way to explain any concept, consider that an Individual is confused whether he should go for a pure term plan or return of premium term plan, and below is the criteria for the same
· Current Age- 25 Years
· Life Cover Required- Rs 1.50 Cr
· Policy Tenure- 35 Years (Cover up to age 60)
· Premium Payment Option- Annually
The Individual comes across the website of Policy Bazaar and decides to compare the difference between the 2 options for Max Life Insurance Company by entering the above criteria:
At first the return of premium term plan may look very attractive to you but let’s look more closely.
In other words, we can say that in order to receive ₹7,35,000 after 35 years, the individual will have to pay ₹8,670 more for 35 years (21,945 - 13,275).
If we do the math right then the individual will earn a mere CAGR of 4.47% pa.
Yes, Let that sink in before we move on.
Now let us say that the Individual is Smart enough to recognize the trap set by Insurance companies and opts for the Pure Term Plan for which he pays ₹13,275 as premium per year and the balance ₹8,670 per year which would have otherwise been invested in TROP is now being invested in an index or active mutual fund which ideally would give you around 12-15% CAGR considering the horizon of 35 years.
We will be conservative and assume that he earns 12% CAGR even then his corpus on maturity will be a mind-boggling figure of ₹41.90 Lakhs.
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To sum it up, Pure Term Plans are the best option to choose for an individual and certainly do make more financial sense as compared to a TROP. In my personal opinion, one should never mix investments and insurance because when they are mixed it leads to very low returns for the investors and are only beneficial for the insurance company and insurance agents.
If you already have a term plan then stay put and do nothing, however, if you don’t have one then make sure you buy the pure term plan and rather think of investing the difference between the pure term plan and TROP in better investment avenues.
If you have any queries regarding the article then certainly do let me know in the comments section, I will be more than happy to answer them.
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