I describe the mechanics of the waiver of premium rider (WP) here and Investopedia defines it here, but today I will look at the economics of it; specifically, is it more efficient to purchase the rider or alternatively, an individual disability income policy?
Let’s look at a 35 year old non-smoking male as an example. The annual premium for a million dollar whole life policy at standard rates is $12,590. The WP is $350, or 2.78% of the premium. For preferred underwriting, the premium is $11,720 and the WP is $330, or 2.81%.
Disability income policies, also known as income replacement policies, are not priced on a preferred/standard underwriting paradigm, but instead based on occupation. Some occupations, such as CPAs and attorneys, received the highest (best) classification while others, such as a gas station owner or a carpenter would receive the lowest, with many occupations falling in between.
The annual premiums for a disability income policy with a monthly benefit of $1,000 (approximately the same as the whole life premium) and the same parameters as most WP (a waiting period of 180 days and a benefit period of to age 65) are as follows: 5A (best classification), $230; 3A, $392, and A, $1,247.
This indicates that from an economic perspective, the WP is clearly better than an individual policy for the person who falls in the A classification. The slight difference in premium for the 5A and 3A classifications make it, for all practical purposes, a wash, at least from an economic perspective.
We will now look at an example with the same parameters, just substituting a female for the male. As females have increased longevity and morbidity over their male counterparts, we should expect the results to be different.
The whole life premiums and WP for both standard and preferred underwriting are $10,140, $410 and $9,790, $390, respectively. That is expected; lower life insurance premiums, due to longer life expectancy and higher WP, due to increased morbidity.
The only difference in the individual disability income was I used an $833 monthly benefit to more accurately reflect the whole life premiums that would be waived. The annual premiums for 5A, 3A and A are $282, $495 and $1862. Clearly, the A is much better off with the WP as opposed to the individual policy. The WP presents a slight advantage to the 3A and a slight disadvantage to the 5A.
The purpose of this exercise is to demonstrate that inefficiencies exist in the marketplace. It is up to you and/or your advisor to find them and exploit them to your advantage.