Monday, April 26, 2010

My DIY ROP Life Insurance Policy

As you know, I'm currently in the process of purchasing a $500,000 term life policy for the benefit of my sister, who has recently taken in my parents. I had my medical exam last Friday and Accuquote just confirmed that it received my application. I'm told the underwriting process takes about 4 to 6 weeks, so I should be getting my policy by my next birthday. (Gaaaaaah. I share the same birthday as Michael Vick?? Ugh.)

*Ahem* I digress.

Assuming that my health exam results are "excellent", my annual premium for a basic term life policy should be $595, or about $50/month. I was also quoted $1,250/year, or, $104.17/month for a Return of Premium ("ROP") policy.

ROP policies will allow term life insurance policyholders to recover all or part of their premiums paid over the life of the if they do not die during the stated term. Basically, with an ROP policy, I'll be paying an insurance company $104.17/month now, to get back $104.17/month 30 years later. (By my calculation, the yield on the additional ROP premiums would be about ~3.98% APY over 360 months.)

Any claim that the net cost under an ROP policy is zero, ignores opportunity costs or illiquidity. More importantly, the additional premiums are wasted if the policyholder does die during the term.

This site gives an objective explanation of the pros and cons of ROP policies. But ultimately, I think the most compelling argument against the ROP policy is:
"Why Shouldn't I Get ROP Term Life Insurance?

The main reason people don't get ROP term life insurance is that it costs more. It can cost up to three times as much as term life insurance.

Some financial advisors also suggest that if you can afford ROP life insurance, then you should consider getting regular term life insurance and investing the difference."
Although I'm convinced that the ROP policy is not worth it, I'm intrigued about getting a "refund" of my premiums. I wondered whether I can DIY my own ROP policy?

Confession: Although I have enough money to pay this year's premium, I just realized that I don't have enough room in my monthly budget to pay for subsequent years' premiums. In order to pay for my life insurance policy, I'll need to reduce my monthly student loan payments from $1,478/month to $1,373/month (for the "pretend" ROP policy), or, $1,428/month (for the basic term life policy).

My Plan: I immediately set aside $595 for my basic life insurance premium and an additional $660 for my hypothetical ROP premium for this year. I created a sub-account in my Smartypig account (2.01% APY) specifically to park my "pretend" ROP premium. I also adjusted my budget by reducing my SL payments to $1,373/month. I plan to save and/or invest the additional $55/month "pretend" ROP premiums.

I can already hear the trolls - - "The extra $55/month is better spent paying down your ginormous student loans!! You're such an idiot. No wonder you got yourself in such a horrendous financial hole." And quite frankly, I can't argue with the trolls, since they're right. My private SLs have an APR of 3.547% and are likely to go higher in the upcoming months. But I want to point out that I banked this year's "pretend" ROP premiums from my future spending earmarks, not from my emergency fund or future student loan payments. So I don't want to hear how paying down 3.547% APR is better than banking at 2.01% APY. I get it. I really do.

And I've decided to proceed with my DIY ROP plan because I'll still be able to pay off my private SLs in 2 years with or without the additional $55/month. (Even at the reduced $1,373/month payment, I'll be paying over 3 times the minimum monthly payments owed on my private SLs and over twice the minimum monthly payments on all of my SLs combined.) But the biggest reason why I'm doing this now is because I highly doubt I'll remember to start setting aside my "pretend" ROP premiums several years down the road when I payoff my SLs.

Although I parked this year's "pretend" ROP premiums into a savings account, I intend to dollar cost average my future monthly hypothetical premiums into my Fidelity non-deductible IRA account with commission-free ETFs. In essence, my gamble is whether my "pretend" ROP investments can match or beat 3.98% APR, or even 3.547% APR.

Only time will tell...