Philosophically, financial advisors can have quite polarized viewpoints when it comes to the relative importance of protection and accumulation benefits of life insurance. On one end of the spectrum is a “buy term and invest the difference” philosophy that prioritizes protection above all else at the lowest cost possible. On the other end of the spectrum, the philosophy relies heavily on the accumulation aspects of life insurance, promoting insurance as a primary (if not the only) vehicle for saving for retirement. As is often the case, it is possible to go too far in either extreme.
Return Of Premium (ROP) term insurance offers a unique ‘middle ground’ strategy that might warrant more attention than it currently receives. ROP term insurance offers standard term life insurance coverage with a rider that returns all premiums paid (tax-free) in the event that an insured outlives the term of their life insurance coverage. So, for instance, if an insured buys a 30-year term policy for $1,000 per year and outlives the entire term of their policy, the full $30,000 premium paid will be returned to the policyowner tax-free.
While the mechanics of ROP term insurance are straightforward, the potential ROI from such policies is often misunderstood. A common criticism of ROP term is that a policyowner is “…just getting the money you paid toward premiums” and it is, therefore, “money that has lost out on years of compound interest.” However, this is the wrong way to think about ROP term insurance, because it is neglecting the value of the insurance that was obtained throughout the term of the policy. A fairer comparison would be to back out the cost of comparable term coverage and then treat the difference in cost between the two policies as the effective ‘investment’ that ultimately results in receiving the tax-free return of premium at the end of the policy term. And when ROP term insurance is looked at through this lens, the ROI can actually be quite attractive.
The return potential of ROP term insurance is attributed to various factors, including (a) the tax-free nature of the return of premium, (b) a form of mortality-credit-enhanced yield inherent to ROP riders (i.e., some insureds will pay for the ROP rider and pass away without receiving anything from the rider), and (c) an element of lapse-supported pricing within ROP term policies (i.e., many policyowners will purchase coverage and either intentionally or unintentionally let it lapse, resulting in premiums paid without receiving any return of premium benefit).
As a result, for those who know they want to purchase term coverage and keep it in place for the full term, adding an ROP rider is effectively an opportunity to add a side accumulation account to term coverage with some unique investment characteristics that can be quite attractive (similar to the attractiveness of mortality credits within income annuities). Some caveats to consider as well. First, since you do have to keep the coverage in force to reap the benefits, insureds may lose some flexibility to replace a policy with a cheaper alternative that may become available in the future or just let the policy lapse because they decide they no longer want the coverage. Second, the dynamics described above actually result in longer-term policies generally being cheaper than shorter-term policies, so the ROI tends to be most attractive for 30-year term policies. Third, and perhaps most important of all, the market is quite thin and at the time of writing this, there appears to only be one carrier in the market.
Ultimately, for clients who want term coverage and are willing to commit to maintaining coverage for the full term, ROP term insurance has some unique characteristics that can make it an attractive consideration. In addition to the financial benefits, the return of premium may give peace of mind to clients who are otherwise averse to carrying prudent coverage due to the ‘use-it-or-lose-it’ nature of term insurance. So although ROP term insurance may fall in an awkward middle-ground of providing both protection (primary) and accumulation (secondary) benefits that is not particularly popular among advisors, ROP term insurance may be worth a closer look!