A Better Life Insurance Policy?

Insurers now offer inexpensive term policies that refund premiums when the policy matures. Is one right for you?

Nobody likes buying life insurance. But if you could get a low-priced term policy that promised to give you back your premiums if you don't die, would it sound more appealing? That's what a handful of companies, including Fidelity & Guaranty Life Insurance and AIG American General, are hoping.

During the past year, a new product has started to garner a lot of attention within the insurance industry. It's called a return of premium (ROP) policy. It's meant to appeal to people shopping for an affordable term life policy who hate the idea of getting nothing back on their so-called investment if they don't die. Previously, the only other option was to consider whole life and other permanent life insurance products that build up a cash value. But those policies are often too expensive for young families.

Here's how ROPs work. Just like term life, you buy a policy for a set amount of time — say, 30 years. You make your payments every year, and in the event that you pass away, your heirs are paid the face value of your death benefit. Should you outlive your policy, the insurer sends you a tax-free check for the full amount that you've spent on premiums over the lifetime of your coverage. In the words of one agent, it's a win/win situation.

The rub: price. In order to guarantee you your premiums at the end of the 30 years, the insurer charges you an additional 40% to 60% over the cost of a standard term policy. So a 40-year-old nonsmoking man, for example, would pay $755 a year for $500,000 worth of term life insurance, according to AccuQuote.com, but would spend $1,105 — or 46% more — on an ROP policy.

Is it worth the money?

We at SmartMoney.com don't like the idea of paying more than you have to for life insurance. That's why we recommend standard term life for most people. But we have to admit that the most competitive ROP products aren't a bad deal.

To figure out whether an ROP policy is the way to go, you need to consider the additional cost of the policy and figure out how much you could earn if you bought a cheaper term life policy and invested the remainder on your own. We asked Jim Hunt, a life insurance actuary and consultant for the Consumer Federation of America, to run the numbers for us. Based on the difference between two competitive term policies and the most competitive ROP policy, he figured that a consumer could count on getting a tax-free return of 5.6% to 7.8% by investing in an ROP. In today's market, few would argue that that's a bad investment.

There's more to these policies, however, than just the rate of return. In most cases, if you drop your coverage at any time before the end of the term, you end up with absolutely nothing. And in the meantime, you just spent roughly 50% more than you needed to for life insurance.

We know: You don't plan on canceling your policy. No one does. Yet, you might be surprised at how often consumers do just that. Twenty five percent of people who buy permanent insurance (which includes a savings vehicle and builds up a cash-surrender value) cancel it within the first three years, says Hunt. And 35% to 45% of people drop it within the first 10 years, he says. (For our Life Insurance Glossary, click here.)

Why do people discontinue their policies? Well, sometimes they die. Most of the time, however, they are sold a policy that doesn't suit their needs, says Harold Skipper, a professor and chairman of the risk-management and insurance department at Georgia State University. If the premium proves to be too expensive, families decide to drop it. Or, as is more often the case, a person's needs change (perhaps there's a new baby in the family), which means additional coverage is required. And, oftentimes, additional coverage spells an entirely new policy.

That's not to say a new policy is necessary. Chances are, you could just add additional coverage to your current policy. But as the old saying goes, insurance is sold — not bought. Insurance agents work on commission, and the agent makes a higher commission on a policy with a larger face value, warns Skipper. And if you're no longer working with the original agent who sold you your policy, the new agent has no incentive to maintain your old policy and simply add on more coverage. The incentive is to sell you a completely new one.

Indeed, the insurance companies are counting on people dropping their coverage. It's the only way they can afford to offer this type of product, at these prices, and guarantee that you'll see 100% of your premiums in the end, says Consumer Federation of America's Hunt.

Choosing a Plan
If you're still interested in buying an ROP policy, there are some other things to consider. First, these policies are best suited for younger people who need 30 years of coverage. When you run the numbers for a 15- or 20-year policy, says Byron Udell, chief executive and founder of AccuQuote.com, the plans aren't priced as competitively. That's because the insurance companies need to charge you more in order to generate enough money to cover your payoff over a shorter period of time, he says.

If you're not in great health — say you have uncontrolled high blood pressure or diabetes — you may be better off with a universal life plan, says Bryan Place, principal owner of TermAssistant.com. (Universal life is similar to whole life, but it also offers policy holders flexibility on premium payments by allowing them to pay less during the early years of coverage). It costs about the same amount as an ROP policy, he says, and offers more flexibility. You can continue coverage after the 30 years, and it builds up a cash value before the end of the term. So if you want to walk away from your policy early, you can still get some cash back.

Finally, the most important thing you can do is buy the right amount of insurance to cover the financial burden your death would impose upon your family. If you need $500,000 of coverage, make sure you get it. If you can't afford the premium on a half-a-million-dollar ROP policy, don't even consider it, says Udell. It's more important to buy what you can afford for the right face value.