What is (ROP) Return on Premium Term Life Insurance and Should I Buy It?

by Efin Advisor | October 8, 2009

We get some important questions at Efinancialblog.com about saving readers money.  One such query regarded the “Return on Premium Term Life Insurance” or ROP for short. What is it and should I be concerned about it, or even buy it where available?  In this case, an excellent answer has been provided across the blogosphere by Certified Financial Planner Jeff Rose and his blog “GoodFinancialCents.com.”

Jeff writes about how a young business owner client inquired about purchasing a term life insurance policy to provide financial security to his wife and young child in the event of his unexpected passing.  A term life policy makes total sense for his situation, but what he wanted to add is something called a return of premium rider.

For those who 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. Or is it?

No Brainer or Break Out the Calculator?

As Jeff points out, at first glance the return of premium rider seems like a no-brainer.  He writes “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.  The bigger question is the central one: 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….

More Math: ROP Rider vs. Regular Term Insurance

To illustrate the cost difference between purchasing regular term insurance vs. one with the ROP ride, Jeff ran a test for a 30 year old male, assuming he was in excellent health.  We’ll examine 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 take the difference of $460 per year and invest it and average 6% over the 30 year period, 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.  But wait — what happens if  we average an 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.

Getting Smart: The Other Important Considerations

The scenarios Jeff ran were different than what he had predicted.  However, when he analyzed the cost differential, he was relying on a few big assumption. First, that the  person could afford to pay the higher premium. Secondly, that the erson will keep the policy for the entire 30 year period. Finally, that the the cost of insurance won’t decrease.

When Does Purchasing ROP Rider Make Sense?

Typically, you wouldn’t purchase ROP on policy as long term, as 30 years.  Where it is more common is with term polices of  10 to 15 year in length.  With such a shorter time horizon, the ROP makes more economic sense.

Would an ROP rider make sense for you? Is this something the insurance industry should take into account when designing new life insurance products?

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