Disability Insurance Feature - Return of Premium

1. 1. Michael James

   Nice analysis. It’s interesting that even with very conservative investment returns, ROP is a very bad idea (for the client). I agree with you that any financial product heavily pushed should be examined carefully.

   The apparently small added cost of ROP reminds me of extended warranties on electronics. You’re essentially being asked if you’d like to pay extra. After all, it doesn’t seem like very much more money to get 50% of your premium back later.

   Jul 14th, 2008 @ 11:06 am

2. 2. Cash Canuck

   25 bucks a month? That’s insane. I used to sell insurance and “riders” never usually cost that much. When I was in the business the big deal was pushing ROP for critical illness policies. The major reason I left insurance was because I felt “dirty” for selling a certain product based on what was best for the company, as opposed to what was best for the client. I had a job offer from an independent financial planner but the foul taste in my mouth led me to leave the financial industry altogether.

   Jul 14th, 2008 @ 12:15 pm

3. 3. FrugalTrader

   Yea, i’m thinking that the premiums for the ROP generate high commissions. What other “riders” were pushed?

   Jul 14th, 2008 @ 12:31 pm

4. 4. John

   I recently signed up for disability insurance through Rene at Insure Your Future (http://www.disabilityinsuranceadvisor.com). We discussed the return of premium and he encouraged me to take the difference in premium and invest it in a CD or somewhere else that would generate interest instead of letting the insurance company hold it. Made sense so I went that way.

   Jul 15th, 2008 @ 10:32 am

5. 5. gicman

   That’s a great comparison but you assume people will invest that extra premium money, fat chance. They will cash it out the first time they see that big screen TV they always wanted. Sometimes forced savings work, just not for the financially astute readers of investing blogs like this :)

   Jul 15th, 2008 @ 6:50 pm

6. 6. John

   If you don’t have the discipline to put your money to work, you probably aren’t informed enough to search out disability insurance. You’re most likely waiting for the government to bail you out of the mortgage you can’t afford.

   Jul 16th, 2008 @ 7:04 am

7. 7. Tim Landry

   Understand that I am a believer in ROP and allow me to explain why. FrugalTrader’s argument is great (to a point) in theory however it ignores a basic fact of North American culture - WE DO NOT SAVE - WE SPEND. According to an article published in CA Magazine.com, the average RRSP contains $50,000 - that will do NOTHING for us when we need it. “Buy Term and Invest the Difference” MUST BE an older concept than I am (I am almost 63) but it only works IF YOU DO IT. Now - let us take ROP as an option on DI (By the way I have specialized in Living Benefits for just a couple of months short of 40 years) - it should be sold as the LAST option to a client who has already purchased the important riders - regular occupation extension, guaranteed insurability and Partial/Residual. It should be sold to YOUNG clients - particularly males - who believe nothing can happen to them. Even if the client does not buy it, he often agrees to see us because we tell him he collects either way.

   Now - let’s look at the 4 possible ranges of scenarios
   (1) You NEVER claim - you have only paid half what you put in.
   (2) You go on claim and NEVER go off. You really do not care - because premiums are being waived - you are not paying tehm
   (3) You have a limited duration - say 4-5 years of claim. Your refund is delayed but you still collect for the premiums you paid and did not collect on
   (4) You become a chronic claimer - you request that the option be removed.

   Understand - the important thing is you buy this protection, You can no longer rely on Group Plans - please do not even consider Board of Trade or other such plans because the definitions and exclusions significantly reduce coverage.

   Oh - and by the way - if an advisor sells ROP, his commission is REDUCED.

   Practical - not theoretical - PLEASE

   Aug 20th, 2008 @ 10:23 am

8. 8. FrugalTrader

   Tim, thanks for the great counter argument, much appreciated. Most of the readers of this blog ARE savers and are attempting to get financially ahead. The article simply points out that if you have the discipline to put aside the money, the ROP isn’t the best “feature” to be added onto disability insurance.

   Aug 20th, 2008 @ 10:38 am

9. 9. Tim Landry

   I agree - if you are a saver then there is no real value to it - but I still come back to the basic argument that everyone needs - and very few have - this type of protection. Our most important assets are our health and our ability to earn an income. Without the income, discipline does not help you much. The only occupations that are well protected are professionals - and basically only two of them - doctors and dentists. PLEASE - unless you are working solely for the pleasure you get out of it - make sure your income is protected. I learned when my brother survived his car accident - only to get Hepatitis C from the transfusions needed to save his life - how truly valuable this protection is and how limited the protection offered by Group Insurance is in today’s world.

   Thanks for the comment by the way - my Lord a place where posts are responded to professionally!

   Aug 20th, 2008 @ 11:52 am

10. 10. Brian Poncelet, CFP

    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

    Aug 20th, 2008 @ 12:55 pm

11. 11. Tim Landry

    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”

    Aug 20th, 2008 @ 2:03 pm

12. 12. Glenn Lester

    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.

    Aug 28th, 2008 @ 4:01 pm

13. 13. FrugalTrader

    Glenn, thanks for stopping by. My calculations above assumed that the amount invested would return 2.5% after inflation and taxes. Note that the ROP benefit does not account for inflation which eats away at it’s benefit over the years. After the 22 year mark, even a high interest rate savings account would come out ahead of the ROP benefit.

    Aug 28th, 2008 @ 4:24 pm

14. 14. Glenn Lester

    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%

    Aug 28th, 2008 @ 11:22 pm

15. 15. FrugalTrader

    Hi Glenn, for the high interest savings account, I was assuming a 4% interest rate which I admit is a bit high for today’s standards, but was the norm a few months ago.

    I like the idea of reviewing in 8 year increments. However, the ROP has a risk factor involved that is not accounted for in your returns calculation, the risk of injury and losing your benefit.

    Aug 28th, 2008 @ 11:38 pm

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