One of the downsides of disability insurance is paying money for something you hope you never use.
But what if you could get a full or partial “refund” on your disability insurance if you never file a disability claim?
In a way, you actually can. Some disability insurance policies offer an optional feature called a return of premium rider.
But before you automatically assume it’s a benefit worth paying for, it’s important to understand how it works and what it ultimately costs.
What is a return of premium rider?
A return of premium (ROP) rider is an additional feature that reimburses you for premiums paid if you outlive the term length of your disability insurance policy.
In addition to disability insurance, ROPs may also be offered on life insurance and other types of insurance policies.
By paying extra for your coverage, the insurance company agrees to return some or all of the premium paid at a specified interval.
How much does a return of premium rider cost?
Return of premium riders can be expensive. The cost varies by company and other factors, but a policy with the rider may cost 60 percent to 80 percent more than a similar policy without the rider. That means a policy that would normally cost $4,000 a year would increase anywhere from $6,400 to $7,200.
How much does a return of premium rider pay benefits to the policyholder?
The amount you get back will vary by policy. Carriers have a variety of payback options for return of premium riders.
Some may pay a percentage of your total premiums, minus benefits received, every five or 10 years. A typical percentage is 50 percent. So, for example, if you paid $30,000 in premiums for five years, your ROP rider would “refund” $15,000 in premium payments, less any benefits you received from the policy.
Others will only pay ROP benefits upon policy cancellation or lapse, death of the insured, or if the insured reaches a certain age, typically 67. The percentage of premiums refunded in these scenarios may range from 50 percent to 100 percent.
A policy may enable the insured to a get a percentage refund paid every 10 years or upon death or policy expiration.
If you receive a return of premium while you still own the disability insurance policy, you may have the option of taking the funds in cash or applying it to future premium obligations.
What happens if you file a disability claim?
With disability insurance, there’s a decent chance you’ll file a claim at some point.
Estimates range from 25 percent to 30 percent of American workers will endure some type of temporary disability during their careers that will prevent them from working.
You likely don’t get any money back if you file a claim. Since return of premium proceeds are reduced by the amount you receive in disability claim benefits, it may only take a few months of receiving benefits to wipe out your ROP proceeds. If that occurs and you don’t receive any of the return of premium, you will have essentially paid a 60 percent to 80 percent higher premium for the same benefit.
Are you better off investing the difference?
Some advisers suggest a better strategy is investing the difference between a normal long-term disability policy and one with an return of premium rider. The idea is that you may:
- Accumulate a larger sum over time with invested assets than with ROP proceeds, provided your investment earns a decent return.
- And you’ll have the investment funds regardless of whether you use any of the disability policy benefits.
The longer you have the policy and the better the investments perform, the more the investment option becomes the better option. Using the numbers above, assume a disability insurance policy costs you $4,000 annually. You considered also buying an ROP rider for an extra $2,400, but decided to invest that amount instead.
If your investments earned an average annual return of 5 percent, in 15 years they would be worth close to $60,000. At 8 percent annual return, they would be worth $78,000. On the other hand, if you had an ROP rider that paid back 80 percent of paid premiums, the proceeds would be equal to $76,800 ($6,400 x 15 x 80%).
In 20 years, the $2,400 annual investment at 5 percent would be worth close to $90,000, and $130,000 at 8 percent annual interest. The ROP proceeds after 20 years would be $102,400.
In addition, advisers point out that ROP proceeds are not adjusted for inflation. Therefore, when you consider the purchasing power of money today versus, say, 20 years or more down the road, you’re only getting a partial return of your premiums paid.
Want to learn more about income protection? Try this:
The 2019 Ultimate Guide to Physician Disability Insurance