How to choose premium term insurance plans

The insurance regulator IRDA was in the thick of news recently after it went after single premium insurance plans saying they needed to be taken off the shelf. While the industry stalwarts continue their flip flop on topic, we decided to check whether is makes sense to buy single premium term insurance plans in India.

But before we do, let us understand the basics and then see whether it makes sense to fit it in your overall financial planning.

How do single premium term insurance plans work ?

As the name indicates, single premium plans are policies that need you to pay the premium just once and never during the term of the policy. The other more common option is when investors have to pay regular premium each year during the term of the policy. In the single premium version, you need to pay just once and continue to enjoy the cover for the full term of the insurance policy.

Here is this explained diagrammatically.

Why are they good ?

Well, for one, the policyholder thinks that he will pay the premium just once in his life and it’s all done. The thought does have some merit because paying premiums regularly each year calls for discipline. If you miss it, then your policy might lapse.

You might argue that the ECS facility is there where in the premium can be automatically deducted but then you need to have the money in the bank account for that to go through. So paying the premium just once is easy.
Another reason is that during last minute tax saving season of January to March each year, these are peddled as tax savings instruments as the premium paid is allowed as Section 80C deductions. And gullible investors buy it as a tax saving instrument rather than for protection, which is what insurance is all about.

Why they don’t make sense

For one, the upfront premium is huge. But your insurance advisor would reason otherwise. He would give the following comparison. Data is for Kotak Preferred Term Plan.
If you would go for a regular premium plan, you will pay Rs 10,590 if you are 30 years old and are looking at a cover of Rs 75 lakhs for 25 years. That makes a total outgo of Rs 25 * 10,590 = Rs 264,750.

But if you take the single premium plan, you pay just Rs 147,444 now and pay nothing for all the next 25 years. Isn’t that a great saving sir, he would reason ? Chances are, most of the folks will fall for this.

Well, let’s do some calculations to check what the real story is.

If you were to park this single premium amount into a FD at say 8% rate of interest, you would fetch Rs 11,795 each year which can easily take care of the annual regular premium. An 8% rate of return is easily achievable from FDs these days – in fact most of the banks are offering a return of 9% – 9.5% on FDs.
Apart from the fact that the regular premium is taken care of by the interest return, your money will also grow over 25 years at 8% rate of return to Rs 235,574 ! So the question is, why lock in your money in a single premium plan when you can use that to pay the regular premium each year as well as make the capital grow.

Not just that, there is another disadvantage to single premium term plans. If you were to die during any of these 25 years, the sum assured is given out to your family but note that you have at this point of time already paid all the future premiums which no longer should have been paid. In a regular premium plan, since the premium payment frequency is each year, you do not have to pay future premiums in case of a claim.

What should you do ?

As you can see, you can save tons of money with the regular premium option. However, the single premium policies are selling like hot cakes.

If you are an earning person who is not sure about his future earning potential and income, then going for a single premium cover might make sense. If you are buying to save income tax or investing because you are sitting on a pile of money, get in touch with a qualified financial planner for better use of your money.

Note that while all this argument is made for term insurance, the same holds true for any single premium policy, be it ULIPs, endowment or others.