Here's why experts feel zero-cost term plans is adding little value to consumers

Are you wary of the ‘use-it-or-lose-it’ nature of pure term insurance plans? Intrigued by an insurance plan that promises to refund every premium you’ve ever paid? Enter the zero-cost term insurance plan.

Since it was launched in 2022, many companies have brought out their offerings to tap into customer demand. Companies like Max Life Insurance, HDFC Life Insurance, Bajaj Allianz Life, Canara HSBC Life Insurance, and ICICI Prudential Life provide these ‘zero-cost’ term plans, allowing policyholders to close the policy and receive a full premium refund or continue until maturity without any cashback benefits.

For the uninitiated, there are three fundamental forms of term insurance plans: The regular term plan, where the policyholder receives coverage for a fixed duration; the term plan with return of premium or TROP plan, which gives policyholders the option to get back premiums in case they survive the policy term; and, finally, the zero-cost term plan, which is a hybrid of the other two and gives policyholders the option of reclaiming premiums during the term.

Though this last option seems enticing, investors must read the fine print carefully. Besides, once you choose one type of policy, you cannot switch to another.

The distinctions

Before you proceed, there are a few more differences you need to keep in mind. In the regular plan, if the policyholder passes away during the term, the nominee is entitled to a death benefit, either as a lump sum or as periodic payments. Since it’s purely coverage for risk, there’s no maturity benefit if the policyholder outlives the term. These plans are budget-friendly, offering substantial coverage against life’s uncertainties.

In TROP plans, if the policyholder passes away, the nominee receives the sum assured. Alternatively, if the policyholder survives, they get back all the premiums paid minus goods and services tax (GST) at 18 per cent upon maturity. However, TROP plans typically have higher premiums, roughly 1.8-2 times the cost of regular plans.

The zero-cost plans provide the return of premium feature at a reduced cost. In such plans, policyholders have a one-time option to exit when they have fulfilled their financial obligations, receiving a refund of all paid premiums minus GST. The nominee receives the death benefit in the event of the policyholder’s premature death.

What’s the play?

Many perceive zero as a symbol of emptiness or a lack of value. Some argue philosophically that zero may not even exist. But not the insurance industry. Here, strange as it sounds, the zero is linked to associated costs.

So, “zero cost” is nothing but the ability to reclaim all premiums paid after you reach a predetermined point during the policy term or after reaching a certain age, most often at retirement.

Rakesh Goyal, Director of Probus Insurance Broker, says, “Insurers label certain plans as zero-cost term insurance due to the inclusion of a special exit value option or a return of premiums. This labelling often serves as a marketing strategy to attract potential buyers.”

Rhishabh Garg, Head of term insurance at insurance aggregator platform Policybazaar.com, says the special exit option is not available at any time of the policyholder’s choosing. “It comes with a condition of minimum policy duration and a particular window where you can exit, which is at an age when financial liabilities are generally over.”

Though the return of premium may look enticing, the calculation of its worth may not be so straightforward. Col (Retd) Sanjeev Govila, CEO of financial planning firm Hum Fauji Initiatives, says, “‘Zero-cost’ is more of a mind game. The value of the premium paid today is much more than its value when the insurance company gives it back.”

What you need to know

The policies do address a common concern: paying premiums for term insurance that might never yield any returns. But there are some downsides to consider.

First, the policy terms are long, often 30 to 40 years or more. Then there are age-based restrictions. Some plans have specific age brackets for availing of the feature, excluding younger or older applicants.

Now, about early exit: Here, too, conditions apply. The refund is only available at specific predetermined points. Besides, exiting early means losing the raison d’être of a term insurance plan, the death benefit.

Policyholders must weigh the opportunity cost. The premiums paid could be invested elsewhere.

For instance, a 30-year-old purchasing an ICICI Pru iProtect Smart zero-cost term plan will shell out an annual premium of Rs 16,287. However, opting for a regular term plan until retirement at 60 would mean a yearly expense of only Rs 12,686 over 30 years, accumulating a substantial difference of Rs 1.08 lakh in premiums. If, however, a person were to invest the difference of Rs 3,601 (SIP of Rs 300 a month) in mutual funds with anticipated returns of 12 per cent, their corpus could swell to about Rs 10.5 lakh over 30 years. Likewise, if the sum were put in an RD at the current rates of about 8 per cent, the returns would be Rs 4.5 lakh. That’s almost the cumulative sum of premiums paid for a regular plan. So, your regular term plan can become a zero-cost one.

“Zero-cost term insurance has a higher premium than a pure term plan. Higher to such an extent that if the difference is invested year-on-year for the length of the term, even with a modest return, the corpus would equal the premium paid,” says Amol Joshi, Founder of investment services platform Plan Rupee.

Paying Rs 16,287 annually for 30 years will add up to Rs 4.89 lakh. Yet, after subtracting GST at 18 per cent—which comes up to Rs 2,931.66—the total return upon retirement reduces to Rs 4 lakh.

Most importantly, you need to watch out for hidden costs. While premiums are generally tax-deductible, the refunded amount might be taxable, depending on the plan and your tax bracket. And there could be additional policy charges or fees.

Who does this suit best?

Despite these drawbacks, zero-cost term policies are suitable for risk-averse individuals. “People who prioritise a return of premiums paid if they survive the policy term over the absence of maturity benefits in traditional term plans can consider buying this policy,” says Garg.

“If you are, say, in your early 20s, and you are buying a zero-cost policy with a term of 40 years or more, then it is a decent benefit. You don’t lose anything by opting for it. Those comfortable with higher initial costs and complexities in exchange for potential future benefits could consider zero-cost term plans,” adds Govila. Those who prefer straightforward, low-cost coverage might find regular plans suitable, he says.

So, if you’re enticed by the zero in the policy’s name, think hard before choosing it. 

 

@imNavneetDubey