Is Return of Premium Life Insurance Too Good to be True?

First of all what is it? Premium, as far as insurance is concerned, is the term used to describe the amount of money you pay the insurance company in order for them to provide coverage. Return of Premium is a type of life insurance that does just what it says it does, returns that premium to you. With this type of life insurance, once you reach the end of your term, the insurance company gives you a check for all of the monthly insurance payments you’ve made over the years. The life insurance is essentially free. That’s a deal that’s impossible to beat. Or is it?

First you have to ask a few questions. Why would an insurance company offer this type of insurance if they don’t even keep the money? There has to be something in it for them. Well the answer to this question comes in a couple layers. First off, what do insurance companies do with all the money they get every month? A portion of it goes towards paying claims, but the rest is invested to increase their profits. Therefore, insurance companies want to boost those monthly premium payments as much as possible. Offering return of premium insurance helps the insurance company sell more policies because they can pitch it as free insurance, but it also boosts total premiums because the Return of Premium policies are more expensive.

Secondly, there’s a bit of a catch to these policies. If you don’t keep making your payments until the term is completely up, the insurance company doesn’t pay you back you premiums.  Let’s say at age 40 with a few young children, you purchase a 30 year Return of Premium(ROP) policy. You pay the premiums for 20 years, but then at age 60 you get laid off and you can’t find a new job. Your budget needs to tighten up in a hurry. Since you realize your kids are now in their 20’s and 30’s and they’ll be able to support themselves if something happens to you, you surrender the policy. If this happens, you will have ended up paying much more money for an extra benefit that you won’t even get to take advantage of. The insurance company is banking on you having to cancel your policy before the term is up and not having to pay you back.

Consider this:

A Return of Premium Policy typically costs from 50%-100% more than a regular term life policy. A healthy 30 year old male can buy a 30 year level term policy with $500,000 of coverage for about $35 per month. If he outlives the policy he simply walks away having paid into it for 30 years. That same male can purchase a 30 year Return of Premium policy for about $55-$70 per month on average. Purchasing the regular term policy will cost the policy owner $12,600 over 30 years, while the Return of Premium policy owner will pay out $22,500 over the same time. If the ROP policy holder keeps the policy for 30 years, he gets the entire $22,500 back(Sweet!), where the regular policy would leave him $12,600 poorer.

But let’s think this through a bit first, if the insurance company just takes the extra money you pay for the ROP policy and invests it in order to return your premiums, wouldn’t it make sense for you to consider taking that extra money and investing it on your own? In this case, the extra cost of a ROP policy is about $33 per month. Investing that $33 per month on your own with a modest 7% return, would grow to $38,800 over the 30 year period (the 30 year average stock market return of 12% would have grown your $33 per month investments to over $100,000!).

Purchasing a standard term policy and investing the difference results in an additional $16,300 for the policy holder vs. purchasing the Return of Premium policy. In addition to superior returns, buying the less expensive regular term policy and investing the difference also gives you more flexibility and safety. This is because you do not need to keep the policy in place for the entire term in order to access your investment savings. So if you find yourself unable to afford your regular term policy 10 years before the term expires, you’ll still have accumulated close to $17,000 which is yours to keep no matter what.

Does it ever make sense to buy a ROP policy?

Rarely. There are probably only a couple situations where you may want to consider a Return of Premium policy.

1. You have tons of money already invested in other areas, are maxing out all of your retirement accounts and you expect to be in a high tax bracket when the term ends. An ROP policy can serve as an alternative investment for diversification and the return of premium paid by the insurance company is not taxable.
2. You are not committed to setting money aside or investing and if you had a choice of what to do with the extra savings, you would be tempted to simply spend it. Discipline is a very normal and common challenge, and in this scenario there is some benefit to the ROP policy because it acts as a forced savings account. However, someone who has financial discipline concerns may find it difficult to maintain the policy payments for the entirety of the term.

My philosophy is typically to give as little money as possible to insurance companies. Pay them for the right amount of insurance protection and stay away from expensive extra features. Then set aside as much money as you can for yourself!

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