Recently, a younger business owner client of mine was inquiring about purchasing a term life insurance policy.
Like me, he recently just had a child and was concerned about providing financial security to his family in the event of his unexpected passing.
A term life policy makes total sense for his situation, but what we he also wanted gave it a twist. In addition to 30 year term life policy, he wanted to add what’s called a return of premium rider. For those that are not familiar, the return of premium rider allows the policy holder to get a full refund of all the premiums paid at the end of the contract.
At first, it sounds like a pretty good deal. The most common complaint that consumers have with life insurance is that if you don’t die, all the money goes directly to the insurance company. If this is the case, then purchasing the return of premium rider seems totally worth it.
Cost of Return of Premium Rider
At first glance, the return of premium rider seems like a no-brainer. One piece of information that you need to know is that the rider comes with a price. The ROP rider on average will run 20%-40% higher than purchase a policy without it. In addition, you have to keep the policy for the entire contract period to get a full refund of your premium. So then the question remains, does it make sense to pay more for the rider since you know you’re getting all your premiums back? Let’s take a closer look….
ROP Rider vs. Regular Term Insurance
To illustrate the cost difference between purchasing regular term insurance vs. one with the ROP ride, here are some quotes that I ran. In our scenario, I am using a 30 year old male, assuming he is in excellent health. We are going to get a quote on a 30 year term life policy with a $1,000,000 face value. Without the ROP rider, the annual premium will cost approximately, $720 per year for a total of $21,6000 premiums paid over the 30 year period. By adding the ROP rider, the premium jumps to $1,180 per year, for a total outlay of $35,400. That’s a total difference of $13,800 premiums paid ($460 per year) or a 63.88% increase.
Invest the Difference
Since I’m a firm believer of long term investing, my initial argument would say, go without the ROP rider and invest the difference. Let’s see how my theory holds up. If we take the difference of $460 per year and invest it and average 6% over the 30 year period, it looks something like this:
By averaging 6% return, you will have accumulated $36,366 over the 30 year period. Subtract the $21,600 you paid in premiums over that period and your net amount is $14,766. As you can see in this example, purchasing the ROP rider seems to make sense. Hmmm…..Gets you thinking, right? Now let’s see if we average 8% return:
If we are able to average 8% return over that same period, we accumulate a total of $52,110 and after subtracting the premiums were left with $30,500. Compare that to the $35,400 we would get back with the ROP rider, and we’re still in the red. If we can average closer to 10% return, then we have a greater chance for the normal policy to be more economically viable.
One major thing to consider is that the money returned to you with the ROP is not inflated for inflation. As you can imagine, $35,400 today will not get you as far 30 years from now.
Few More Considerations
I have to admit that the outcome of the scenarios I ran were different than what I predicted. What we have to keep in mind is that when I analyzed the cost differential, we are relying on a few big assumptions:
- That the person can afford to pay the higher premium.
- The person will keep the policy for the entire 30 year period.
- The cost of insurance won’t decrease.
This and other variables would have a dramatic impact on the long term results of this scenario.
When Does Purchasing ROP Rider Make Sense?
Typically, you wouldn’t purchase ROP on such a long term policy. Where it is more common is term polices 10 to 15 year in length. You usually see this being used in buy/sell agreements between business partners where each partner buys insurance on the other’s life. With such a shorter time horizon, the ROP makes more economic sense.
Disclaimer: I have purchased 3 term life policies and never have opted for the return of premium rider.
What about you? Have you purchased a term life policy with a ROP rider?
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photo credit: KayVee.INC
{ 3 comments… read them below or add one }
I saw an article you had written, and I had a question. I have part of the article so you can see what I am talking about.
You said: To illustrate the cost difference between purchasing regular term insurance vs. one with the ROP ride, here are some quotes that I ran. In our scenario, I am using a 30 year old male, assuming he is in excellent health. We are going to get a quote on a 30 year term life policy with a $1,000,000 face value. Without the ROP rider, the annual premium will cost approximately, $720 per year for a total of $21,6000 premiums paid over the 30 year period. By adding the ROP rider, the premium jumps to $1,180 per year, for a total outlay of $35,400. That’s a total difference of $13,800 premiums paid ($460 per year) or a 63.88% increase.
If we are able to average 8% return over that same period, we accumulate a total of $52,110 and after subtracting the premiums were left with $30,500. Compare that to the $35,400 we would get back with the ROP rider, and we’re still in the red. If we can average closer to 10% return, then we have a greater chance for the normal policy to be more economically viable.
I am saying: I quickly read your article, and maybe I am missing something, but it seems to me that in the 8% scenario, the normal policy is already more economically viable, and your NOT in the red. If you had the ROP and had a total outlay of $35,400, over 30 years, then $35,400 is ALL you would get back at the end of 30 years. In the 8% scenario, you have $52,110 (all from your investment and got nothing back from the premiums) at the end of 30 years. So actually, you have $52,110 at the end of 30 years, which is over $16,000 more than what you would have gotten back if you had ROP. For this example, I do not see the need to subtract the $21,600 from the $52,110. It seems that at the end of 3o years, with ROP, you get back $35,400, and WITHOUT ROP, and investing the difference in premiums, you had $52,110, even though you got non of your premiums back. Please let me know if I missed something.
@ Jason.
Thanks for the comment. At first glance what you say makes sense, that the $52,110 you get from investing the difference on the ROP is more than the $35,400 you would get back with the ROP.
I think where our views differ is that with the ROP, at the end of 30 years, your expenses are $0 because you get it all back with the ROP. In the other case, sure you made $52,110 off of the difference, but you had expenses over the 30 year period of $21,600 for the insurance.
Does that make sense?
Jeff,
If you are investing the difference, then there’s no need to subtract any expenses at the end. They’ve already be accounted for out since you are investing the DIFFERENCE.
Another way to look at it is like this:
You have a budget of $1180/yr to spend on SOME combination of services. You are interested in term life and a return on investment for the remainder of your budget. You can invest the difference yourself or let the insurance company do it for you.
The ROP policy in your scenario is equivalent to purchasing the term policy and investing the difference with an annual return of 5.x% (something really close to 6%).
To beat that offer/proposal, all you need to do is invest the difference and earn an average annual rate of return HIGHER than that 5.x%.
ALL of your scenarios beat the ROP offered by the insurance company. I think you did the right move by purchasing three term life policies and skipping the ROP route. I’m about to do the same myself. I think your gut instincts were correct the whole time.