No you're not. You're paying partly for the phone and the rest is subsidised by O2. Which they have to recover from your contract. Which is why you get less minutes for your contract.
An example:
iPhone 3GS 16GB on contract £44.05/month 1200 texts/500 messages/unlimited data. Free phone. 24 month contract.
£44.05 x 24 = £1057.20
iPhone 3GS 16GB at £444.40 with the Simplicity contracts above at £19.57.
£444.40 + £19.57 x 24 = £914.08
It's not exactly a rip-off when you basically have the phone on credit.
It is a rip off when you know the average costs of other phones without a contract and compare them...