What is Return of Premium Life Insurance?
Pros and Cons of Term Life Insurance with a Refund Guarantee
Jul 18, 2009
One of the biggest downsides of term life insurance is that neither the benefit payment nor any other refund is paid out if a person outlives the policy. In effect, it's possible to lose all the money paid into term life insurance. Return of premium life insurance offers a solution that rewards people for staying alive by giving back the entire amount of premiums paid.
How Return of Premium Life Insurance Works
Return of premium solves the biggest complaint about term life insurance, in a neat and simple way. If the policy holder outlives the policy, all of his or her premiums are returned.
How does this differ from normal term insurance? Imagine a 35-year-old man takes out a 30 year term life insurance policy worth a million dollars upon his death. The policy costs $1000 annually, or $30,000 over the 30 years. If this were a standard term policy and the hypothetical gentleman lived to be 65, his life insurance policy would expire and he would be owed absolutely nothing.
A return of premium policy, on the other hand, would have cost more for the same coverage – say $1500 each year or $45,000 in total. But it would return all $45,000 in premiums paid at the end of the 30 years, assuming the insured party is still alive. Effectively, a return of premium policy for the same man would have cost him nothing.
Return of Premium – Sound or Poor Investment?
It's easy to conclude from the numbers that return of premium costs nothing – but is that really true? In fact, return of premium may cost more money than it saves.
Considering inflation over 30 years, there is a substantial price to be paid for an unused return of premium life insurance policy. What's more, it's important to keep in mind the amount of interest that could be earned on the same money invested over that period of time – not only because the policy holder could be earning that capital, but because that's exactly what makes this business so profitable for brokers and insurance firms. That $1000 or $1500 is invested by the insurance firm, paying dividends in interest over the years of a policy while the policy holder essentially loses money thanks to inflation.
Finally, factor in the additional cost of return of premium versus standard insurance. For a 30-year term, return of premium can cost as much as 50% more than a standard policy. For a 10- or 15-year term, it can increase by as much as 200% because insurance companies have less time to invest the capital and earn interest themselves.
Anyone considering return of premium life insurance might be wise to purchase a standard term policy instead, and invest the difference for his or herself.
Sources
- Dodge, Mark, "Is Return of Premium Life Insurance As Good As It Sounds?" SoundMindInvesting.com, March 2006.
- Wiener, Leonard, "Getting a payback," USNews.com, 17 October 2004.
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