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:

1. That the person can afford to pay the higher premium.
2. The person will keep the policy for the entire 30 year period.
3. 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?

photo credit: KayVee.INC