Return of premium (ROP) term products have had excellent success in key markets in recent years. This article examines the roots of this success and identifies both new market applications and potential product enhancements (and issues).
In its simplest construction, ROP offerings consist of a base term policy, generally of 15, 20, or 30 years’ duration. During this period, the premiums are paid on a level basis, with the premium level either guaranteed or sold on a current basis.
An ROP rider then provides for the return of all policy premiums if the policy is held until the end of the stated level term period. (Note: For technical reasons, the base term policies typically allow for the payment of an annual renewable type term premium if the policyholder wants to continue coverage after the level term period ends.)
The ROP rider also generally provides for payment of a reduced percentage of all premiums, if the policy lapses before the end of the level term period.
Such riders are attractive for buyers who expect to continue coverage for the long term. If the cost of ROP term insurance is $1,000 a year, then at the end of 30 years, the owner will get a check for $30,000–income tax free (because there is no contract gain).
Obviously there is a cost to the coverage, and the incremental cost of the ROP component varies significantly by length of level term period.
These policies have been sold on a sophisticated simplified underwriting basis to individuals in middle income markets, especially to those who have taken out mortgages on their homes within some recent period of time. This market link provides for some market self-selection (why take out a mortgage if one’s health is seriously impaired?)
The market is huge, although the industry has yet to see the impact of a correcting housing market on sales of ROP policies.
Large distribution entities have developed powerful systems (not just IT systems) to identify recent mortgage activity and to reach mortgage holders efficiently.
For definition of life insurance purposes, the ROP amounts constitute cash value. Therefore, care must be taken to assure that the contract complies with the applicable requirements of the Internal Revenue Code. It has been somewhat disconcerting to see some recent contracts that appear to have compliance challenges. Company actuaries developing such contracts must use precaution, as the calculations are not as simple as they might otherwise seem.
Because mortgage insurance is taken out generally during a customer’s working years, the lump sum payment from an ROP product may occur near the end of the working lifetime. What an excellent point in time that would be to offer long term care coverage, and what an excellent time to use the lump sum payment to help fund that LTC policy.
Two alternatives to do that come to mind. Either the client can buy a single premium life with an LTC feature, or they can buy an annuity with an LTC feature.
The recently passed and signed Pension Protection Act has provided a huge incentive to use either structure. This is the first time annuities have been allowed such an incentive; life with LTC policies already had an opening under the Health Insurance Portability and Accountability Act of 1996. (Incidentally, such incentive is applicable to properly structured immediate annuities, too.)
The core ROP product package can and certainly should be used to fund other life event insurance needs. Marriage and birth of a child are two that come to mind. Funding for college has considerable appeal as well, with payments staggered so the ROP is based upon college entry year, as opposed to being paid all at once.
Although much of the discussion here has focused on middle market applications, the reality is that mortgages can be very large, as in some western states. This would put the product beyond the reach of simplified issue programs. Consequently regular underwriting is essential for addressing the needs of such customers. For those situations where regular underwriting is required, market-based selection control is not essential.