Return of Premiums: A Consumer Dilemma
By: Jack Di Nardo CFP, CLU, CH.F.C.
Recently, several radio commercials about critical illness insurance have aired in the Toronto-area featuring celebrities such as Darryl Sittler, who tragically lost his spouse to a critical illness. The ads promote the benefits of this type of insurance and often end with an enthusiastic statement about how you can even get all of your premiums back.
This money-back feature grabs the attention of consumers. It is often the first point raised by them. The life insurance industry calls this a Return of Premium Rider (ROP) and it has been promoted off and on for over 20 years. The basic idea is that you pay an extra amount of money to enable you to get back the premiums paid over, typically, a 15- or 20-year period. You would also give up the insurance coverage.
Promoted as an investment, agents often talk about the "attractive" after-tax investment returns that paying for this ROP can generate. They often say something like: "Imagine if you could get all of your car insurance premiums back after 10 years! Wouldn't that be terrific?"
Critical illness insurance is designed to provide a lump sum, tax-free benefit to anyone diagnosed with a life-threatening illness, such as heart attack, stroke or cancer. There are some 20 other covered conditions, but the three mentioned account for an estimated 85% of actual claims.
The catch is that you can expect to pay some 30% - 50% more for your critical illness policy in order to get this money-back feature. For example, a $100 monthly premium will increase to about $140.
There are three things to consider before purchasing the money-back option. The first is the contractual terms and conditions to qualify for the refund. The second is what is the purpose of insurance in general and why buy any insurance at all? And finally, what other uses could you have for the money?
A key contractual condition for qualifying for the premium refund is the degree to which you have received benefits under the plan. If you actually had a critical illness within 10 years, for example, it would reduce or eliminate your ability to qualify for the refund. The actual terms and conditions will vary for each contract and company. Some companies may offer a smaller percentage premium refund, such as 50%, while others may prorate the refund by the number of claims-free months. The bottom line is you may not receive the amount of money you expected.
The purpose of insurance is to reduce or eliminate a financial risk by transferring that risk to a company that can withstand the financial loss associated with that risk. What might be a catastrophic financial loss to you becomes a cost of doing business to the insurance company.
Interestingly, statistics show that claims are lower when a consumer buys an ROP on living benefits policies such as critical illness insurance. On the one hand, the consumer wants the insurance company to assume the financial risks but on the other hand does not really believe that they will ever actually need it. Thus they buy the money back feature to cover all of their bases.
This may create a dilemma for you. What if you are diagnosed with a critical illness just four months before qualifying for the refund? Submitting a claim at this time may cause you to lose some or all of the refund. The decision becomes whether it makes more financial sense to file a claim or not to file a claim. Health considerations are much more of a priority at this point than financial decisions.
Another problem is if you cannot afford the policy after, say five years, due to job loss or other financial emergency, then you would lose all the extra premiums paid into the plan. This would not be the case if the same money were, for example, invested in an RRSP.
Finally, what else could you do with the extra money you pay for the ROP feature? Could you a take vacation, save for a child's education, pay down your mortgage or buy new furniture? Consider consulting a qualified financial planner and insurance specialist to carefully review your insurance options.
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