A popular “cash back” life insurance product is about to get a whole lot more expensive, or may vanish entirely, thanks to a little-known regulatory change that will take effect Jan. 1, 2010.
The insurance at risk is called return-of-premium term life insurance — commonly called ROP. It differs from traditional term, or temporary, life insurance policies by offering a bonus if you live longer than the policy.
“Return-of-premium policies appeal to people who feel that living through a term policy is a bad thing — as opposed to dying,” says Steven Weisbart, senior vice president and chief economist at the Insurance Information Institute. Living through a policy should be considered a good thing — but people often feel cheated that they paid into the policy for years, but didn’t profit financially from it, Weisbart says.
If you have a traditional term life insurance policy and you live through the length of your policy — typically 10 to 30 years — the policy expires and the insurance company pays you nothing. People who have ROP policies get back 100 percent of the cost of insurance if they outlive their policy.
But big changes are coming in ROP — as a result of the economic conditions and a major regulatory change that takes affect Jan. 1, 2010. Here’s what consumers might expect:
- Significant increases in the cost of ROP policies.
- More uniform and fair paybacks for policies terminated early.
- Availability of ROP policies in more states.
- Fewer companies selling ROP policies.
Aside from unfavorable economic conditions, the biggest reason for the radical changes in ROP coming with the new year is something few people have heard of outside the insurance industry — it’s called Actuarial Guideline 45.
Return-of-premium insurance costs significantly more than traditional term life insurance — at least 30 percent more and up to three times as much. The insurance companies invest the extra amount and use the gains to pay for the end-of-policy refund.
“You pay more, and we put the extra aside and invest it so we can earn the amount to pay you back,” says Alan Lurty, senior vice president and head of business development for ING U.S. Insurance.
What’s more, the cash you get back at the end of the policy — often tens of thousands of dollars — is income-tax free, because it is technically just a refund of your own money.
While return-of-premium accounts comprise only 5 percent to 10 percent of all term policies written each year, according to Byron Udell, founder and CEO of AccuQuote.com, they have grown steadily in popularity over the past decade. However, consumers may only have until the end of this year to lock in what attractive rates remain. So far this year, Udell says, Genworth Financial has discontinued its ROP products and ING has dropped one version.
The devil in ROP is often in the details: Policies differ widely between the half dozen or so companies that offer them, says Dominique Lebel, senior consultant for Towers Perrin, a Stamford, Conn.-based consulting firm.
Historically, the biggest difference between policies existed in the built-in provisions regarding what happened if you chose to close your policy before the end of your term.
Generally, Lurty says, “These policies gradually increase the amount you can get back each year you hold the policy.”
With a 30-year policy, a customer who closed the policy after five years may get nothing back; 10 percent back after 10 years; 30 percent return after 15 years; and 100 percent at 30 years.
Other companies, however, may not have given any interim refunds — just a total, lump sum at the 30-year point.
Those variations and inconsistencies are what the National Association of Insurance Commissioners wanted to address with Actuarial Guideline 45, which is part of the Accounting Practices and Procedures Manual, which all states follow.
With the new guideline, the refunds will be uniform, industry wide, regardless of which company wrote the policy.
That new rule will mandate that each company pay back a significantly higher portion of the premium earlier than they do now if you cancel the policy before the end of the term.
Because the companies have to be prepared to pay back more money, sooner, the policies likely will get more expensive.
Lurty says he doesn’t know yet how much ING will raise rates, but suspects every return-of-premium policy written next year will cost significantly more.
“We are still in the middle of pricing. But I have seen at least one other competitor do their pricing, and they are looking at 30 percent to 50 percent higher than they were,” he says.
More states, fewer companies
Aside from higher prices, the next biggest likely effect of the rule change is that more people may have access to return-of-premium policies than did in the past.
“Under the current rules, the insurance commissioners in a couple of states didn’t approve this product at all,” Lebel says. “This will bring the policies in line with the rules those states were looking for, and it should mean more people will have access to these policies.”
Pennsylvania and Utah, for example, banned these policies because the refund schedules conflicted with state law.
At the same time, however, some companies that now offer return-of-premium policies are planning to respond to the new rule by discontinuing them, Lebel says.
With an internal return on investment on a typical ROP averaging 6 percent, says Udell, and a long-term interest rate on insurance company investments stuck at 3 percent, insurers can’t afford to provide coverage, pay claims and return all the premium. “The solution,” he says, “is to drop the product or raise rates dramatically.”
Who should jump
Return-of-premium policies aren’t for everyone. Many financial advisers steer middle-class customers away from these policies, suggesting they take the difference in price and invest it in something like a mutual fund where they potentially could earn many times the amount promised by the policy refund.
On the other hand, return-of-premium advocates point out that the policies force you to make the regular payments, and stress the tax-free benefits, which are often very attractive to high-income people.
If a typical term policy cost $1,000 a year less in premiums than a return-of-premium policy and you invested that amount yourself for 30 years at 6 percent annual interest, you could earn more than $80,000. That would be some $20,000 more than you would have gotten back, typically, from a premium refund at the end of the policy term.
ROP policy advocates, however, stress that the premium refunds are guaranteed, while mutual fund returns are not.
Because the new rule takes effect Jan. 1, 2010, time is running out before the new, higher premiums kick in.
“If you are interested as a consumer, you should get in this now or at least before the end of the year before rates go way up,” Lurty says.