While return of premium (ROP) riders are a hot commodity in today’s term life insurance market, insurers must take the time to prepare adequate analysis of the risks associated with the riders to avoid getting burned.

Policyholder Value
Value is measured by the yield achieved by the policyholder on the additional ROP premiums, given the return of all premiums at the end of the level period. This yield is assumed to be after-tax. The general consensus is the premium returned at the end of the level premium period is a return of basis and, therefore, should not be taxable.

A more conservative interpretation may require the cost of insurance be deducted from the basis. If PS58 rates are assumed, the appeal of the ROP rider is greatly diminished. This article assumes that none of the premiums are taxable. Yields for representative premiums currently offered in the market are shown in Figure 1.



Return on Investment
Assumptions for term products with ROP riders need greater scrutiny than term products without the riders. The return being earned on the insurance company’s invested capital becomes more important with an ROP rider.

The ROP rider requires significantly more capital to support than a stand-alone term program, and companies in today’s economic climate need to ensure the invested assets will achieve returns similar to that assumed in pricing. At a minimum, companies should use investment rate sensitivity tests for term products with ROP riders similar to those used for permanent products.

Expected Lapses
As noted in our first article on these riders, persistency is one of the greatest risks of term products with ROP riders. Because these products are highly lapse supported, lapses are a key assumption to analyze. With the cash value increasing faster than the annual premium in later durations, very low lapses should be anticipated.

To examine lapse sensitivity, we created a realistic 20-year term product where the ROP rider premium is set to 80 percent of the gross premium. One pricing cell — male, age 45, best class nontobacco — was used for the analysis. In addition to the original lapse assumptions (which include conversion rates), three additional sets of lapse rates were tested (Figure 2). The impact on a full portfolio may be more or less dramatic than what is illustrated in this simplified example.



One might assume some mortality improvement to occur with lower anticipated lapse rates. The assumption used in this analysis is that lives lapsing have a 20 percent lower mortality expectation than those persisting. This 20 percent is not based on any mortality studies, but it can be considered a reasonable assumption for illustration purposes. The resulting profitability is presented in Figure 3, and it should be apparent that results vary widely. Careful analysis of sensitivity results may help a company determine the most reasonable assumption and its tolerance for this type of risk.


R.I.P. for ROP?
With all factors considered, do ROP riders maintain their appeal to policyholders and term writers? For policyholders, yields generated by the ROP rider may be thought of as competitive in today’s interest rate environment, considering rates on treasuries (which are not taxable) at the beginning of the month were approximately 4.50 percent on 10-year and 5.25 percent on 30-year. A minimum yield of five percent for products with ROP riders would provide policyholders a fair value, but what would ROP premiums need to be to achieve that yield level? (Figure 4)



Looking back at our worst-case sensitivity (Sensitivity 3 in Figure 3) and using an ROP premium of 136 percent on a 20-year product to achieve a five percent yield, the ROI generated is 26.5 percent and profit margin is 8.3 percent.

This ROI, profit margin and conservative lapse scenario might make the rider appealing to a term writer. The assumptions won’t keep you up at night, and the higher premiums generate better commissions per sale for your producers.

More conservative lapse scenarios, however, might create significantly higher premiums than other products in the market, which could decrease sales and create producer complaints. The high ROI that can be realized at this conservative but not unrealistic lapse assumption demonstrates that a yield to the policyholder of greater than five percent is achievable for the above example.

Closer scrutiny of assumptions for term products with ROP riders than the review usually given to the assumptions of term products without ROP riders might be all a company needs to develop a competitive and profitable rider. Adjusting premiums to accommodate more conservative assumptions can still provide a product of value to policyholders.

For more information about return of premium riders, please contact your account representative or call our Sales department at 704.344.2700.