Analyzing Return of Premium Life Insurance
All life insurance needs can be expressed as IF you die and WHEN you die. For the IF you die needs, term insurance is your best bet. In general, you just match the length of the term with the need and buy the least expensive coverage from a reputable company. A new breed of term insurance is gaining popularity called Return of Premium (ROP) term insurance.
These new policies are still term insurance, but they have a twist. At the end of the term period you have a couple options:
- You can continue the contract at a higher premium.
- You can get 100% of the premiums paid returned to you, or
- You can forfeit the return of premium for a reduced amount of fully paid up life insurance.
Of course these additional options come at a price. The real question is; are the new Return of Premium features worth the extra premium? To do the analysis we should first explore which option we would likely take.
Most term insurance policies let you renew at a higher premium. Generally, they are not designed to entice renewal. The renewal premiums are very high (somewhere in the neighborhood of eight to ten times the original premium for a 20 year term) and would only be attractive for someone who had become ill and it looked like the death benefits would be paid sooner rather than later.
It is also unlikely that you would forfeit the return of premium in exchange for a fully paid up life insurance policy with a reduced death benefit because of the IF you die original need. Unless your needs have changed, chances are that at the end of the term period you would no longer have a need for the coverage.
The most likely option is that you would exercise the return of premium option.
Let's take a sample case I recently did for a client.
This client is a 32 year old, non-smoking female who would probably qualify for standard non-tobacco rates. She has a 20 year need for $250,000 of term insurance. In traditional term insurance, she selected a policy from (ING) ReliaStar which would have a $33 a month premium. Her return of premium option is with [company name removed at their request] which has a premium of $46.20 a month and would return $11,088 after 20 years. Keep in mind that she needs the insurance so $33 a month is effective spent already and that provides only the insurance coverage she needs. The question is really is it worth spending an additional $13.20 a month to get the return of premium?
By doing a time value of money calculation (PV = 0, FV = 11,088, PMT = -13.20, N = 240) we come to the conclusion that we are earning 10.77% returns on the additional premium. Considering the only risk lies with the financial stability of the issuing insurance company, that seems like an excellent proposition to me.
Put another way, if she purchased the traditional 20 year term insurance and invested the additional $13.20 a month, she would have to earn 10.77% in the side fund to have the same $11,088 after 240 months. But since the ROP insurance returns the premiums without tax consequences (there is no gain, you are simply getting your money back) and the side fund would have $7,920 of taxable gains, she would actually have to earn more than 11% to have the same net result.
Not all cases work out as well for ROP as this one did, but by following the same process you can assess if ROP is good choice for you.
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