On Friday evening before leaving for the weekend, Ramesh finds his colleague Karthik hunched over his desk and appearing distraught. The conversation between the two sheds light on what ‘return of premium’ in insurance is and how it plays out.
Ramesh: Your screen shows a confirmation that term insurance payment has been completed. So, why the long face and distraught look?
Karthik: I know it sounds juvenile, but every time I make an insurance payment — term, health or car, I can’t help shake off the feeling that money is being thrown into a bottomless pit. The problem is the instant gratification we get nowadays on purchases, 10 minutes for groceries, 30 for pizza etc. Compare that with insurance payment, which offers a reassurance that somewhere in the distant future when something bad happens, the financial risk will be hedged. The benefits are real, but making the payments takes some convincing.
Ramesh: The reassurance is golden enough for me, but if you are into monetary gratification, you should consider return of premium plans in insurance. You can find them in term insurance, life, retirement, endowment plans and even in health covers.
Karthik: I didn’t know there are insurance plans that return premiums. How do they work?
Ramesh: You pay premiums over a defined period to the insurer who offers the protection as agreed. At the end of the term, the insurer will return the premium in a lump-sum. But the services will not change — the term cover, life cover, annuity payments or indemnity in health insurance. Depending on the product and the policy offer, premiums may be returned along with death benefit in term and life insurance policies.
Karthik: There must be a catch, right?
Ramesh: Obviously, the policies will be expensive from a premium perspective. For instance, term insurance premium for a 30-year-old male will be ₹13,000/year in a normal policy (₹1 crore sum assured). This implies a cumulative payment of around ₹4 lakh whichthe policyholder will never get back if they survive the tenure. But adding a return of premium clause will give you the same sum assured, but at a premium of ₹25,000-30,000 per year.
Karthik: Woah! Why so much extra?
Ramesh: A part of the premium is invested in nearly risk-free (and hence low-yielding) instruments by the insurer to match the premiums paid, apart from other charges related to mortality, health risk and administration.
Similarly, a ULIP or a retirement plan will give 300 to 400 basis points (1 bps is 0.01 per cent) lower return if you opt for return of premium, which in this case is called capital guarantee, compared to a plain-vanilla market-linked return variant. A part of the premium will go into lower-yielding to generate the guaranteed part. Even in annuity plans, the yearly pay-out will be lowered, if the corpus must be returned to the nominee on demise of the policyholder.
Karthik: Thanks for the clarity. It seems to me that return of premium clause is for policyholders who may not commit to the policy over long periods without the promise of some return at the end.