As part of our ongoing plan to make sure we’re properly insured, the wife and I started looking at different insurance options for her. I’ll write up a separate post on how we determined the appropriate terms/coverage levels, but when our insurance guy sent us the quotes he included something I wasn’t expecting: a return of premium rider. In a nutshell, you pay an extra amount above the base premium, but if you don’t use the coverage (e.g. die) before the policy expires, you get back everything you’ve paid in. On the surface this seems like a phenomenal deal for the consumer – get the coverage you need and all your money back if you don’t use it. Well like so many things, there’s more to the story and you need to do a little bit of analysis to understand how good a deal it is.
But first, a couple of quick facts:
- The policy we were looking at was a 30 year term policy with a $400k death benefit.
- The annual premiums would be $557 standalone or $1,135 if we elected the return of premium rider a difference of $578 per year.
- Over the course of the entire policy term, we would pay $16,710 standalone vs. $34,050 with the rider. (The big difference, of course, is that $34k would be coming back to us if she doesn’t kick the bucket before then)
So now, on with the analysis…
The first big thing you probably noticed is the difference in cost between the two options. In fact, it more than doubles the cost to add the return of premium option! Remember, however, that the entire premium outlay would come back to you, so you’re getting back not only the extra amount but what you would have paid for the coverage anyway. To help keep things straight here’s a simple breakdown of the different ways it could play out. For simplicity, I’m assuming that any death occurs at the end of the policy so timing of death (which is irrelevant for these purposes) doesn’t muddy the waters.
|Standalone||Return of Premium Rider|
|Don’t die before policy expires||Die before
|Don’t die before policy expires|
|Total Premium Paid||16,710||16,710||34,050||34,050|
|Net Premiums Paid||16,710||16,710||34,050||0|
|Death Benefit Paid||400,000||0||400,000||0|
Regardless of if you buy the return of premium option, you’d receive the full death benefit if you died before the policy expired 30 years out. The only difference is the amount of premium you paid. If you bought the policy standalone and didn’t die, you’d be out your nearly $17k in premium. If you did by the rider, your net cost is zero since all the premium gets refunded at the end of the term. Getting back to one of our original points, this looks like a phenomenal deal. What do you have to lose?
Let’s step back and think about this for a second. Ignoring the scenarios where you die (who cares, you’re dead!), you have two different sets of potential cash outflows:
- a $557 annual cash outflow for 30 years and $0 cash inflow at year 30, or
- a $1,135 annual cash outflow for 30 years and a $34,050 cash inflow at year 30
The first represents just the standalone insurance policy where you pay for the term coverage, and the second is with return of premium. The trick is to realize that the cost of the death benefit is the same regardless of whether you choose the return of premium option or not. That means that cash flow #2 has two parts: the standalone insurance (cash flow #1) and the return of premium rider-specific cash flows. Subtracting #1 from #2 yields the following:
A $578 annual cash outflow for 30 years and a $34,050 cash inflow at year 30
As you can see, you’re effectively paying money over time for the right to receive a lump sum in the future. There’s another word for that: savings! That’s all a return of premium rider is: savings tied to an insurance policy. Now that we know what it really is, we can evaluate if it’s a good deal or not by determining the interest rate implied by the cash flows. In this case, it works out to a little over a 4% for the 30 year policy term.
So are return of premium options a good deal? It depends. In this example, you’d have to decide how a 4% return for 30 years compares to your other investment options. Remember too, you’re locked into the payments; if you can’t make the full premium payment the policy lapses and you’re SOL. The flip side is this makes the savings kind of forced and the rate guaranteed; you’d have to have the discipline to save the difference for 30 years and invest at greater than 4% returns on average to come out ahead. Depending on your willingness or ability to do either of those things, you may be better off to do it this way.
My issue with the return of premium is that it was pitched to be as a sort of best of both worlds with no downside. As you can now see what it really is, I wish they were a bit more forthright about it just being forced savings instead of trying to sex it up. We ultimately decided against buying the rider as we valued the flexibility of deploying the cash elsewhere more than the guaranteed return potential. We haven’t really had an issue saving either and wanted to have our insurance serve only its intended purpose: a cash benefit in case of premature death of either me or my wife. You may have different objectives, so it’s something worth exploring if the numbers make sense for you. You’ll still have to calculate the implied returns, or better yet, get your agent to provide it to you! Ours did.
John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives.
He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.