What Is Return of Premium Life Insurance?

Like most auto insurance products, traditional term life insurance policies confer payouts or refunds to policyholders or their beneficiaries only if certain conditions are met. In the case of auto insurance, policyholders looking for compensation must be able to demonstrate that the covered vehicle has been damaged, destroyed or lost. For their beneficiaries to receive death benefits, traditional term life insurance policyholders must die within the specified term of their policy.

Whereas most auto insurance policies must be renewed each year, term life insurance policies tend to last from 10 to 30 years. Since they aren't guaranteed to pay out, term life products are substantially cheaper than whole life insurance products, which cover the insured over their full remaining lifespan. Even so, most term life policyholders outlive their contracts and forfeit any premiums that they paid to keep them in force.

Return of premium life insurance exists to  mitigate the disappointment  that many traditional term life policyholders feel when they realize that they've outlived their policies and spent thousands of dollars that can't be recovered. Today,  5 to 10 percent  of all term life insurance policies offer this form of protection.

Since insurance companies must guarantee themselves a profit on most of the policies that they write, return of premium products cost more than traditional term life insurance policies. Insured parties can expect to pay anywhere from 30 to 600 percent more over the life of their return of premium policy. Their underwriters invest these additional premiums over the policy's term, often earning a substantial rate of return on the funds.

For this reason, longer-term return of premium policies tend to be far cheaper than short-term policies. After all, reinvested 10-year policy premiums have far shorter periods in which to grow relative to 30-year policy premiums. According to AccuQuote, a leading term life insurance policy aggregator, a 30-year return of premium policy may cost just 45 percent more than a traditional policy of the same term. On the other hand, a 15-year return of premium policy may cost 600 percent more than its traditional counterpart.

As an investment, return of premium life insurance offers mediocre returns. According to a  USA Today study, policyholders can expect to earn anywhere from 2.5 to 9 percent more per year versus a traditional term life policy. However, this statistic can be misleading because return of premium policies don't add interest payments to their returned premiums. If they outlive their term, the best result for which a policyholder can hope is to break even in absolute terms. In real terms, their returned premiums will likely be worth less than their initial value thanks to the effects of inflation.

Return of premium life insurance offers some benefits. Whereas traditional term life insurance merely reassures its policyholders that their family members will enjoy some financial security after their passing, return of premium insurance ensures that they have something to show for their foresight. It's also far more affordable than whole life insurance, making it an attractive choice for families on a budget.

Return of premium life insurance has some drawbacks as well. Since it offers a negative rate of return in inflation-adjusted dollars, it compares unfavorably to many other types of investments. What's more, insurers may charge extortionate fees on policies that are canceled early.