The option offered with some insurance contracts to have premiums returned paid after a defined period is a prudent choice for people who want to insure their risk and potentially recover the full or partial amount of premiums, if they do not make a claim.

“Although a good choice for anyone, the return of premium feature is especially suited for those individuals who have hang-ups about acquiring insurance — largely due to cost or because they don’t believe it is necessary — but yet recognize that they face certain risks which can be mitigated by insurance,” says Philip Kung, president of Markham, Ont.-based RGI Financial Services. “They can get peace of mind by insuring their risks and still recover all or some of their money at the end of the contractual period.

“It’s a win/win situation for policyholders,” Kung adds. “Their risks are insured in the event something happens to them.”

And, he adds, if nothing happens, coverage costs are negligible.

ROP riders are typically available with critical illness and disability insurance policies. In addition, the cash value in certain whole life policies can also be effectively seen as a refund of premiums, although it is not formally recognized as such.

In general, there are three forms of ROP — upon expiry of a policy, upon surrender of a
policy or upon death, says Ami Maishlish, vice president, insurance and financial software with Richmond Hill, Ont.-based CompuOffice Software Inc. He says the policyholder does not know which event may occur, making it prudent to ensure that ROP covers all three situations.

However, he cautions that affordability is a key consideration because the cost of each option varies and in all cases it is more expensive to add a ROP rider to an insurance contract. On average, the cost of ROP is 25%-50% more than the cost of a policy without the ROP rider.

“The terms and conditions of return of premium riders vary from company to company and by type of policy,” says Tim Landry, director of living benefits with MSA Financial Services in Montreal. “Some policies may not even offer the option.”

For example, with CI insurance, the policyholder can receive a 100% refund of premiums after the policy has been in force for a defined number of years, typically 15 years. The policyholder can also get a full or partial ROP upon reaching age 65, or a 100% ROP upon the expiration of the policy, which may be age 75 or, in some cases, 100. Most plans also offer a full refund of premiums at death, providing no benefits have been paid, which is the case with all ROP options. In some cases, a nominal rate of interest is paid on the premiums.

With disability insurance, between 50%-70% of premiums are returned at various periods — on average every 10 years that a renewable policy is in force, or at specified ages, for instance, at 55 and 65. The level of ROP varies by insurance contract.

Although only a portion of a DI premium is refunded, it may be worthwhile to add the ROP rider, Kung says. He uses the example of doctors, who are not normally covered by group plans so often turn to private disability insurance. Hypothetically, if a doctor buys disability insurance without ROP at a cost of $2,000 per year, he or she will spend $20,000 over a 10-year period to insure the risk of disability.

However, if the ROP option is added at a cost of $800 more per year, the cost of coverage will be $28,000. But with the ROP rider, the doctor could get a refund of $19,600 (assuming 70% of $28,000), making the cost of insurance only $8,400 ($28,000 less $19,600) over a 10-year period, instead of $20,000 without the ROP rider.

Although not normally considered a return of premium, the return of cash value in a non-participating whole life policy is equivalent to a return of premium, says Lawrence Geller, president of L.I. Geller Insurance Agencies Ltd. of Campbellville, Ont. For example, if a policyholder has a whole-life policy whose premiums are paid up after 20 years, the cash value in the policy will normally be greater than the amount of premiums paid, he says. Therefore, if the policy is surrendered, the policyholder will effectively get a return of premiums.

@page_break@For example, a 45-year-old male non-smoker pays $1,205 annually for the lowest-cost 20-year-pay $100,000 whole life policy according to LifeGuide, insurance planning software. The premiums paid over 20 years total $24,100. The cash value of the policy at the end of the 20th year is $25,800. It should be noted that the cash value continues to build up in such a whole life policy even though no additional premiums are required.

In the U.S., a new form of term insurance with an ROP rider is becoming popular. The product is offered for a fixed term of, say, 20 or 30 years and costs more than standard term life insurance. If the policyholder keeps the policy for the contractual period, the full premium plus a nominal rate of return is refunded.

Geller argues that this type of term insurance is not as good an option as a 20-year-pay whole life policy. Term insurance expires at the end of the contractual period, unless renewed. In the case of 20-year-pay whole life insurance, the premiums are paid up for life.

The return of premium option makes the decision to acquire insurance easier. It has been one of the key drivers of CI sales. Landry, however, cautions that it should not be a primary incentive in the selling process. In essence, insurance should be sold based on the need to manage potential risk and not because of the probability of getting a refund of premiums.

The cost of an ROP rider is equal to the cost of the opportunity lost by not investing the additional amount elsewhere, says Maishlish. For instance, an individual can invest the additional premium for a better rate of return. However, this must be weighed against the total amount that would be foregone at the end of the contractual period if the ROP feature is not chosen.

In reality, it is hardly likely that investing the amount used to acquire the ROP option would result in greater value than the actual refund of premiums. Let’s take the case of the doctor above. If the cost of the ROP is invested and earns 8% annually, the doctor will end up with $11,590 ($800 invested each year for 10 years at an annual return of 8%). At the end of the 10 years, it would actually require an annual return of 18.8% to achieve the same result of the ROP (that is $19,600), which is unrealistic without taking undue risk.

Premiums are currently returned tax-free. However the Canada Revenue Agency is yet to issue a formal ruling on the tax status of ROP. “It’s currently not a hot button for the CRA,” says Geller. “The tax status for DI return of premiums has been up in the air for some 13 years, and three to four years for CI.”

At the end of the day, individuals who are reluctant to consider insurance tend to
rationalize the probability of becoming ill, disabled or even dying within a specified period of time. The ROP option can help them make a decision, while reducing their emotional risk. IE