Here is how much you lose in limited premium payment term life insurance!

In a limited premium payment term life insurance, the policyholder pays the premium for only the first few years of the coverage period. This may seem profitable at first sight but here is how much one loses by opting for this

image of a child in shock representative of buyers who understand the actual loss in a limited premium payment term insurance plan

Published: January 14, 2020 at 11:22 am

Last Updated on

Here is an example of how much you lose by choosing the limited premium payment option in term life insurance, also simply known as “limited pay”. It is the oldest trick in the book. Create two pricing options. One with recurring payment for a longer period (say 25 years) and another for a shorter period (say 5 years). The total spend over 5 years is much less than that over 25. It is tempting to assume the shorter option is better. A closer inspection is necessary.

This is a guest post by Ganesh Ranjan who wrote in with this question: Paying my premium in the accelerated plan or limited-term option proves to be 40% cheaper than having to pay the premium for the entire duration of the policy. Which should I choose?

Ganesh then did the analysis himself to recognise that normal annual premium payment is better. He has kindly agreed to share the analysis with freefincal readers.

I was shopping around for term insurance policies when I came across an option of paying the premium for the insurance in a limited-term (i.e pay the entire premium due in 5 years, 7 years and 10 years) with the ICICI Prudential iProtect term insurance plan.

Here are the basics about the coverage. I am 37 years old and I wish to be covered till the age of 65 with a coverage of 5 crores.

Details of the Limited premium payment term life insurance policy
Details of the Limited premium payment term life insurance policy

If I pay for 28 years (i.e. annual premium) I would pay Rs.79,199 every year totalling Rs.22.17 lakhs for the entire duration of the policy. Instead, if I chose to pay it in 5 years, the premium per year for the 5 years is Rs.2,61,147 totalling Rs.13,05 lakhs. Thus the option of paying the premium in 5 years is cheaper by Rs.9,11,837 (i.e. 41%). We shall call this Rs. 9.11 lakh as the opportunity cost.

I thought something was amiss in this since it was possible for the insurance company to provide me 41% discount if I pay in 5 years and make a profit in the process, why shouldn’t I be able to do it?

I hence approached Mr.Pattu from freefincal.com who advised me against the limited-term payment option as it was not going to be cheaper in the long run. When I approached him I thought I wasn’t capable of evaluating through excel both the options. But I played around and came up with 2 scenarios.

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Scenario 1 – I chose the 5 years limited premium payment option

Scenario 2 – Instead of paying ICICI the higher premium for the 5-year option, I would pay the annual premium and assume that I was paying the higher premium and put the difference in the premiums in an FD during each of the 5 years.

In my calculations, I have assumed 6.5% as the rate of fixed deposit interest.

Comparison table of limited premium payment vs annual premium term life insurance policy
Comparison table of limited premium payment vs annual premium term life insurance policy

The net result is that we arrive at the net positive cash flow of Rs.15.66 lakhs in scenario 2 as opposed to net negative cash flow of Rs.13.05 lakhs with scenario 1.

Net cash flow returns of the comparison between premium payment and annual premium term life insurance policy
Net cash flow returns of the comparison between premium payment and annual premium term life insurance policy

Note: I have factored in the reduced premiums if one had chosen the 5-year premium payment option also in scenario 2 as an opportunity cost 

Editor’s note:  Even if you do not agree with all the assumptions made, clearly paying the premium each year is significantly beneficial even if one leaves the additional amount in a saving bank account instead of choosing the limited pay option.

There is yet another message in this post. Ganesh did not know what to choose. All I gave him was a cryptic, “don’t choose limited pay term insurance”. He decided to dig deeper for his own satisfaction resulting in this helpful post. This is proper DIY at work.

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11 Comments

  1. Another plus point to note is in case of insured person’s death during the initial years of policy, one would save a lot in regular paying premium option vis a vis limited paying term plan.

  2. Dear Sir,
    I have very little finance knowledge.

    In my stupid mind, i got a doubt.?

    As per my calculation, Net cash flow can not 15+Lacks, because we miss to deduct the opportunity cost of 23 years.., which means
    In case of 5years payment option, from 6th year on wards no need to pay any thing.
    So i have 80,000 liquid cash in my had, as you suggested if i keep FD @ 6.5% , by end of 23 years this is near about 14+lacks.

    So the Real cashflow or profit is 1+ lack

    Please advise, if my understanding is wrong.
    Regards,
    Ganesh.K

  3. Dear Sir,
    I have very little finance knowledge.

    In my stupid mind, i got a doubt.?

    As per my calculation, Net cash flow can not 15+Lacks, because we miss to deduct the opportunity cost of 23 years.., which means
    In case of 5years payment option, from 6th year on wards no need to pay any thing.
    So i have 80,000 liquid cash in my had, as you suggested if i keep FD @ 6.5% , by end of 23 years this is near about 14+lacks.

    So the Real cashflow or profit is 1+ lack

    Please advise, if my understanding is wrong.
    Regards,
    Ganesh.K

  4. I believe we should also include the scenario where we invest the opportunity cost gained in the first scenario in FD. This should generate some positive cash flow.

  5. To assume a fixed deposit rate of 6.5% is absurd as in every decade rate of interest has reduced by 3%. Moreover interest earned on fixed deposit is taxable.limited premium payment gives me flexibility to get rid of premium payment liability during my peak earning period.limited premium payment has a surrender value plus after 3 years of premium payment if you have financial problem to pay the premium your policy continues with paid up sum assured.this facility is not available in regular pay.looking at the persistency ratio in indian life insurance industry it is almost 40% after 5 years. It means only 40 policies are inforce after 5 years.so my advice is to pay in limited premium pay .

  6. Whether Opportunity cost should be invested in the FD and then it should be compared at the end of the long term ??

  7. I landed in same trap, but was able to get out of that within 15 days of look up period for same ICICI term policy. The simple reasons are :
    1) As stated above, we will be generating +ve cash flow in the yearly premium pay(by investing the different amount)
    2) You have the control over the policy by paying yearly and if incase you`re in position that no longer need the policy then you are good to stop premium (say after age 55)

    Although my initial mindset was to get rid of premium payment liability, but later realized the tactics behind this, so was able to move to regular premium payment option.

    Courtesy: ASAN facebook group that educated and i personally was convinced before i jumped to change the premium term from 5 yr limited –> regular yearly premium pay term!!

  8. What you have written here is just a superficial exploration in this matter. Not only FD interest rates decrease every year, interest gained through FD is also taxable.

    You can revise your article based on these two important factors.

  9. one basic thing is overlooked,capacity of paying much higher premium in case of limited PPT to cover for entire PT at an early age is chosen as other liabilities in life later is bound to increase manifold as u progress in life. At some stage one may find it difficult to continue paying premium for the entire PT.Moreover depositing every 5 yrs. the difference between regular and limited pay premium for FD may not be not be so easy as it appears for various othe unexpected problems that one come across in life as u age.

    1. Come on, 80000 today as premium could be 10% of your annual salary but it might just be 5% of the salary in 10 years time and 2% in 15 years time. So paying premium in the later years should never a problem even if other expenses increase.
      The author has considered FD as the safest option. One can always invest in equity because the tenure here is 15+ years. So the chances of higher returns is very good.
      Also if the holder dies in initial years, he had already paid his entire premium which is an avoidable loss for him even though he will get the sum assured.

  10. Well, when i had the same doubt, i tried calculating the Net present value of all the future payments assuming various inflation rates (without even considering the opportunity cost of investing the additional corpus if limited premium was chosen). Still the yearly premium was a better result than 5 year limited premium.

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