Buying a life insurance policy

Dear Mr. Tan,

I read from your blog that the minibonds and other structured products, earning 5% yield, can be very risky.  I do not wish to take this kind of risk. Is it all right for me to buy a life insurnce product? Although the return is low, it is at least capital protected and relatively safe.

REPLY

If you save $5,000 a year in a life insurance policy for 20 years, the total savings is $100,000. 

The benefit illustration shows the return that you can get assuming the gross return over the next 20 years to be 3.75% or 5.25%. The average is 4.5%. In my view, this is a reasonable projection for the next 20 years, assuming a balance mix of investments at moderate risk.

If you get an average return of 4.5%. you should get $164,000 at the end of 20 years. However, the actual return is lower, due to the charges taken away by the insurance company to cover marketing and other expenses and profit. In most cases, the charges is about 50% of the gain, i.e. $32,000. This leaves a maturity return of $132,000 or a net yield of 2.6%.

I consider a net yield of 2.6% to be unsatisfactory, as it may not be sufficient to cover the rate of inflation.

A good value policy will take away about 25% of the gain, leaving a return of $146,000 or a net yield of 3.5%. As a rule of thumb, the reduction in yield should not exceed 1%.

If you wish to invest in a life insurance policy, you should ask the following questions.

1. What is the projected return on my policy, based on the assumed yield on the investments?

2. What is the amount deducted in various charges to cover the death benefit and expenses?

3. How much, as a percentage of the assumed gain, is taken away by these charges?

4. What is the effecitve reduction in yield?

If the charges is more than 25% of the projected gain, the life insurance policy is high cost and does not give good value to the customer. It is better to buy term insurance for the life insurance cover and invest the savings in an indexed fund (such as the STI ETF). Alternatively, the reduction in yield should not exceed 1%,

Distribution cost of life insurance policy

Dear Mr. Tan,

I read your survey about "life insurance policy". I bought a policy a few months ago, and the agent did not tell me about the distribution cost. I am now aware about it, after reading the survey results. I feel cheated that such a high cost (representing nearly two years of my savings) was not brough to my attention, although it is printed in the many pages of the benefit illustration. Can I seek a recourse now?

REPLY

It is the duty of the insurance agent to disclose to you about the distribution cost of the life insurance policy that you have bought. 

If it is not brought to your attention, I suggest that you should make a complaint to the insurance company and request that the policy be cancelled for a full refund. If the company does not agree, you can lodge a complaint with FIDReC (www.fidrec.org.sg).

You should look at the amount of the distribution cost. If it is a few hundred dollars, it is a fair remuneration to the insurance agents, in which case, you should not make the complaint. However, if it is $1,000 or more, you can make the complaint.

Fair charges on life insurance policy

If a policyholder save $500 a month for 20 years and earn 5% per annum, the gross gain for the period will be $76,000. However, the total deduction to cover the various charges is likely to take away about 45% of this gain. This will leave a net gain of about $41,000 only. This reduces the yield to 2.8%. The reduction in yield is 2.2% (which is rather high).

A fair deduction should be about 25% of the gross gain. This will give a better return to the policyholder, about 4.1%. The reduction in yield is 0.9% (which is quite fair). This reduction is to cover the cost of life insurance, expenses and profit margin.

During the time that I headed a life insurance company, I was able to give a better return to the policyholder by keeping the expenses low and giving a larger share of the profit to the policyholders. They were able to get a better return. The reduction of yield for an endowment policy is about 1%.

Here is a rule of thumb, if you are buying a life insurance policy:

> look at the assumed yield
> look at the net yield, after deducing the charges
> calculate the reduction in yield
> if the reduction is 1% for an endowment policy or 1.5% for a whole life policy, the yield is fair.
> if the reduction in yield exceed these benchmarks, the charges are probably too high.

You can ask the insurance agents to point out these figures that should be shown in the benefit illustration for the policy.