Zero Cost Term Insurance Plans

Zero cost Term Insurance plans work by promising to return your premiums at some fixed date and thereby reducing your total cash outgo to zero. So in principle you could buy a term insurance plan, pay the usual premiums for a set number of years and then forgo the policy and have all your premiums returned to you at this date. Which means you get to avail the benefit without paying anything..

But this doesn't make any sense. Why would an insurance provider offer to extend a term plan at no cost? How would they ever make money, especially considering most companies handle thousands of claims each year totalling hundreds of crores.

Well, the truth is that insurance companies impose several conditions before they extend one of these plans. Consider a case study based on a zero cost plan offered by a large life insurance company in India.

Case Study: A 30 year old is looking to buy a term insurance plan. The insurance provider pitches the zero cost variant to close the sale. The customer agrees. But before they sign the contract, the insurance company will request the individual to buy a policy that matures at the age of 70 or above. They'll tell you that the zero cost variant is only available for policies with a term spanning 40 years or above. They will also tell you that you will have to forego or surrender the policy before the 25th policy year or between the ages of 65 and 66, whichever is earlier. In the case of the 30 year old, the individual will have to forego the policy as soon as they turn 55 to get the premiums back. And once you surrender the policy you cannot renew it again and the policy will stand terminated.

Summary: While these plans are marketed as zero cost options, they come with several caveats and they're not exactly zero cost either. However since you can avail this option without paying extra premiums, you could still be tempted to go for it. However in our opinion, this isn't always advisable.

Imagine you're 35 and looking to buy a term plan. Now if you spoke to our IRDAI-certified advisors they would tell you that you need to select a policy term based on your expected age of retirement. So if you were retiring at 60, we would ideally tell you to buy a policy with a term of 25 years. That way you'd have coverage until your retirement.

The logic here is simple. A term plan should cover your dependents and offer monetary benefits that resemble your own earning potential. And since after retirement your children and spouse don't usually depend on you, it doesn't make sense to buy a term plan that offers coverage beyond this age. Obviously, you could go up to 65 or 70 depending on your own needs, but we don't usually recommend buying a policy that lasts beyond 70 because of the extra premium you'll likely end up paying and the general lack of utility that a term plan has to offer.

Now imagine you are convinced by the logic, you save a few thousand rupees every year and you get a term plan that offers exactly the coverage you need. However the allure of a zero cost option may affect your decision. If you are told that you can avail this benefit only if the policy term breaches 40 years, then you may be tempted to buy a policy that offers you coverage until the age of 75 (your current age 35 + policy term 40) even though you only really needed a policy that lasts until the age of 60. This pushes your premium higher. So while you can avail a zero cost plan without paying an additional premium, you may still end up spending a lot more money than you would have otherwise.

Secondly, the insurance company will return all your premiums at some future date as a lumpsum. But this is not equal to the total cost you end up paying to buy and retain the policy in the first place. The ₹10,000 you pay in premium isn't the same as the ₹10,000 the insurance policy returns some 25 years later. It could be worth as little ₹2,000 in today's money because of inflation. So you have to remember that there's a hidden cost here which doesn't factor into your calculation.

But that's not all, the insurance company will only return the premiums you've paid them during the time the policy remained active. They will not return the GST.

And finally, the insurance company can make this work, because most people forfeit the policy before the term is complete. This is when most of the claims usually pop up. It's in these advanced ages that insurance companies have to make substantial payouts due to the higher mortality rates. But if they can get people to forfeit the policy much earlier, they can get away with paying a much smaller amount. In effect, the economics is always in favour of the insurance company. So the question is - What are the real benefits of buying a zero cost plan?