Disability Insurance Feature – Return of Premium

I’ve been getting quotes for own occupation disability insurance from various insurance agents and they all promote the “return of premium” feature as being the best thing since sliced bread. Whenever a sales person promotes a product aggressively, my suspicion sensor trips and sets off an alarm. In my experience, heavily promoted financial products are usually a better deal for the sales person than for the consumer. Back to the task at hand, is return of premium worth the extra monthly charge? Lets start off with the basics.

What is Return of Premium (ROP)?

Return of Premium is where you pay an extra fee / month for the “potential” of getting some money back after x amount of years. In my case, I would get 50% of my premiums returned to me in 7 years providing that no claims are made.

An Analysis

Say that instead of purchasing the ROP, we invested the amount instead. Below is a table consisting of the premium payback that I was quoted, the payback after inflation, and the invested payback if we were to put the money into the markets instead.

Assumptions:

  • 2.5% inflation.
  • 2.5% return on the markets after inflation and taxes.
  • 0.25% return on the savings account after inflation and taxes.
  • The cost of the ROP is $276.07/year or $25.05/month. Lets assume that I’m frugal and I pay the annual “value” price.

Table: Return of Premium vs Investing

Year Premium Payback Premium Payback After Inflation Invested Payback Savings Account
8 $3,266.80 $2,681.21 $2,747 $2,509
15 $3,266.80 $2,255.61 $2,411 $2,227
22 $3,266.80 $1,897.57 $2,411 $2,227
29 $3,205 $1,566.16 $2,411 $2,227
36 $3,050 $1,253.84 $2,411 $2,227
37 $435.79 $174.78 $559 $553
Total: $16,491.19 $9,829.17 $12,950.00 $11,970

Conclusions

Judging from the table (and my assumptions), it appears that the return of premium payout does not justify the annual fee.

If (and only if) no claims were made over the 37 years of disability premiums, the ROP would pay a total of $9829.17 after inflation. If we were to invest the annual fee instead, returning 2.5 % after inflation and taxes, we would end up with $12,950, a difference of $3,120.83 in today’s dollars. In fact, if the money was simply put into a savings account returning only 0.25% after inflation and taxes, the savings account would come out ahead by $2,140.83.

To put the final nail in the coffin, a factor not accounted for in the table is the “risk” taken when purchasing the return of premium as it assumes no claims are made. If a claim is made, it would would result in a $0 payback!

My conclusion? Instead of ROP, it should be called RIP (off). Before accepting any “extra features” on insurance products, or any product for that matter, make sure to run the numbers first.

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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dansodev
8 years ago

50% ROP !!! I get 100% with my provider. I kinda think that changes everything!

Physician Disability Insurance
12 years ago

You’re right, not necessarily a great benefit for the price. I think there are other policy provisions that would be more important and beneficial for you to add to your policy.

Tim Landry
12 years ago

But “selling” a product is NOT a BAD thing. How many of us walk around without car insurance? (I do but I never learned to drive) or house insurance?Even if our car was destroyed TOTALLY we are looking at a high end loss of what? $150 or $200K if we drive a TOP END car. Our home? Well that is a little more.

46% OF BUSINESS OWNERS HAVE NO DI INSURANCE! How many of us count on our Group LTD? – How many of us can count on our JOB? TODAY?

Our most important assets are our health and our ability to earn an income. If I can get in front of you because of ROP – or because of any other feature – that is a GOOD THING. Whether or not you BUY that feature is not really relevant – at least you will be informed of the risk.

inv.ins
12 years ago

Hey guys,

There is a lot of intelligent debate about the “actual” practicality of the numbers. I very much respect each comment and wish i had the same insight.

But lets consider the fact that the general public is not so technical. The reason why I think there are so many types of add-ons is to better suite the needs of different types of customers.

Return of premiums and all other addons are to help sell the product (insurance) and not a selling point on its own.

Glenn Lester
13 years ago

Hi FT, I don’t understand how you could realistically assume getting a 0.25% after-tax and inflation rate of return from a savings account?? An ING High Interest Savings Account is paying what 3.00%, less 31.15% in marginal taxes for an average $50k/yr Ontarion income earner leaves just 2.07% before inlation which is assumed to be 2.50% and so the net return is -0.43% for the savings option. Compare this to a gross rate of return of about 8.50% for the ROP option less 0% tax because under current tax law this is a tax free insurance pay-out, less 2.50% for inflation and the ROP has a 6.00% rate of return after-tax, after inflation. While dividend and capital gains have preferred tax treatment these investment options come with potentially alot of volatility leaving them poor options to the ROP. I would suggest looking at this situation in 8 year increments and every 8 years ask yourself do you still want the ROP rider or the disability insurance for another 8 years. Below is a chart comparing the various options after-tax, after inflation assuming they could all be reasonably expected to make the same gross rate of return with a high degree of probabillity. (Sorry don’t know how well this will show up).

ROP Interest Dividends Capital
Gains
Gross Rate of Return 8.50% 8.50% 8.50% 8.50%
Marginal Tax Rate 0.00% 31.15% 7.52% 15.86%
After-tax Return 8.50% 5.85% 7.86% 7.15%
Inflation Rate 2.50% 2.50% 2.50% 2.50%
After-tax Real Rate of Return 6.00% 3.35% 5.36% 4.65%

Glenn Lester
13 years ago

Am I missing something here. This is an optional rider to “invest” $276.07 for 8 years to get $3,266.80 back. My calculatations tell me this is about an 8.50% annual compound rate of return – after-tax, guaranteed! How much risk would you have to take in a market investment (GIC won’t work) to get the same results? OK, maybe not totally guaranteed if you make claims in excess of 20% of premiums paid but then you have another return called a disability claim. I agree this is a luxury rider for those with the cash flow that is otherwise going to non-registered investments that I would argure have little chance of making 8.50% after-tax, virtually guaranteed in just 8 years.

Andrew
2 years ago
Reply to  Glenn Lester

Exactly where I was headed after reading this article.

Tim Landry
13 years ago

People often forget that the Guaranteed Insurability feature also guarantees your original occupation class – one reason why I STRONGLY suggest that people who have worked for a company from anywhere from 3-5 years buy at least a small personal policy with this feature included – because if they ever get “down-sized” or just decide to change careers they not only keep this protection but can even increase it using a better occupational class than they would almost certainly otherwise obtain. It is not just a “health” thing – it is also a “country of residence” thing as well as an “occupational class” thing. I would rank it as the most important optional feature – even a bit ahead of “Partial”/”Residual”

Brian Poncelet, CFP
13 years ago

FT,

The best “add-ons” are cost of living (increases with inflation) and partial disability. Also, Future Earnings Protector Option Rider
(Provides the opportunity to increase your monthly benefit regardless of changes in your health).

The ROP is much lower on the list to get.

regards,

Brian