It sounds attractive. You buy a critical illness plan in case you are diagnosed with a critical illness, such as heart attack, cancer, or stroke. If you are still healthy after a certain period of time, you get all your money back!

I’ve been asked many times if the ROP option is worth the extra money. I always say: “it depends on your particular circumstances and needs.”

To understand this, let’s examine the premise behind obtaining this feature.

Let’s say Mary, age 45, wishes to buy $100,000 of critical illness coverage. Ideally she would like to have coverage until she retires at age 65. Her premium is $100 per month. If she wishes to have the ROP option her premiums would be $160 per month.

Assuming her cash flow allows for $160 per month, she has 2 options:

• 1) Instead of paying for the ROP option, invest the extra $60 per month. However, all the premiums paid are gone forever.
• 2) Add the ROP option for $60 per month and get all her money back at age 65.

If Mary chooses option #1:

We assume she will be investing in a non-registered balanced portfolio. We also assume she is paying tax at a rate of 30%.

In order for her to experience the same effect as option #2, her investments need to yield 12% compounded annually.

In other words, if she invests $60 per month in a balanced portfolio earning 12% per annum, at age 65 she would recover both her principal invested ($60 per month for 20 years) and interest equivalent to the total premium paid for the critical illness plan without the ROP option.

Although this is not entirely impossible, it is quite a stretch, especially for a balanced portfolio. She is also taking on unnecessary investment risks to achieve this high rate of return. The advantage, however, is that she does not have to wait for a prescribed period to end and is free to take her invested money out at any time.

(Incidentally, if you are interested in how this rate - known as the Internal Rate of Return - is calculated, contact me directly and I’ll be happy to go over the details.)

If Mary chooses option #2:

She needs not worry about market conditions, as the return of all premiums are guaranteed if she stays healthy. And if she does not, she gets paid $100,000 in a cash lump sum.

Compared with option #1, the internal rate of return for this plan with the ROP option is 12%. In other words, it is AS IF she earned 12% compounded annually on the extra $60 per month invested personally until age 65, just to get all her money back.

This is the stress-free solution for all those needing critical illness coverage and can afford the ROP option.

What about the new Tax-Free Savings Account (TFSA)?

Starting in January, 2009, the government of Canada will introduce a brand new personal savings vehicle, the TFSA, to help Canadians save money tax-free.

If Mary uses this vehicle to invest the $60 monthly difference, the internal rate of return is reduced to approximately 8.6%. This rate is certainly more plausible than 12%, and the market risks are indeed lower. This is a solution which should be considered.

What if your RRSP and TFSA are maxed out?

If you are already contributing to an RRSP and/or TFSA, and can afford the extra premium for the ROP option, then it would make absolute sense to add the ROP option.

What if you can’t afford the ROP option?

As a rule of thumb, I always recommend determining the amount of coverage needed before considering the ROP option.

In the case of Mary, she got the coverage she needed ($100,000) and could comfortably afford the ROP option. It was within her budget.

If she could only afford $100 a month, it would not make sense to reduce her coverage to $50,000, just so she could have the ROP option. After all, isn’t having the necessary money to recover from a critical illness more important than getting your money back?

If $100 is all she could afford, she should get the needed $100,000 coverage and consider at a later date setting money aside by either contributing into an RRSP or TFSA.

Final thoughts:

Consider the ROP option as a desired “beneficial luxury”, and not a “must have” feature.

Consult a financial advisor to examine your options and determine if this feature is right for you.