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Life insurance carriers began offering return-of-premium riders on their term policies in the early 1990s as a solution to the "live-and-lose" dilemma presented by traditional term policies. As the name implies, this rider will allow term life insurance policyholders to recover all or part of their premiums paid over the life of the policy if they do not die during the stated term. This effectively reduces their net cost to zero if a death benefit is not paid. Of course, adding this protection will raise the overall cost of the policy accordingly. In this article, we'll take a look at a new form of policy rider that may be very attractive to investment-minded individuals who are seeking the sensibility of term coverage.Weighing Costs and Benefits
Let's take a look at an example of how to weight the decision of whether to sign up for a return-of-premium rider.
Example 1 - Cost of Premium Vs. Benefit
A 37-year-old nonsmoking male can get $250,000 of term coverage through AIG for $562 per year with a standard rating. If a return-of-premium rider is added on, the cost jumps to $880 per year, an increase of more than $300 per year. Without the rider, the policy owner will pay a total of $16,860 over the life of the policy. The additional rider will thus bring the total cost of the term policy to $26,400.
Note: Quote given is for a 30-year, level-term policy for a 37-year-old male, 6'3”, 220 lbs, 6 points on driving record, nonsmoker, no medications, no diseases. |
For the analytically-minded, the inevitable next question is: will the recovery of this amount of money make it worth paying an additional $9,540 in the meantime? (To learn more about this, see Let Life Insurance Riders Drive Your Coverage and Understand Your Insurance Contract.)Opportunity Cost Analysis
To find out whether the additional cost is worthwhile, you need to do the same type of analysis as used for deciding whether to purchase permanent insurance coverage or buy term insurance and invest the difference. To this end, the opportunity cost of adding the rider to the policy must be calculated using a reasonable set of assumptions.
Example 2 - Opportunity Cost of Adding a Rider
Using the numbers shown in Example 1, if the additional $318 of annual premium that is required to purchase the rider is invested in a stock mutual fund inside a Roth IRA, in 30 years the fund, will be worth a little over $50,000, assuming an annual growth rate of 10%.
In this case the policy owner would be better off investing the difference than adding the rider on to his policy. But this answer is deceptively simple because this calculation doesn't consider such factors as investor risk tolerance or the policy owner's tax bracket. |
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