Monday, August 29, 2005

Life Insurance II - Main Product Designs

For a short glossary of some of the terms and acronyms I use frequently in this post, please refer to Life Insurance I.

OK, now that we know about the main product types, let's go through the main policy designs. There are three main designs, namely the non-participating, participating and the unit-linked.


The easiest of the three to understand would be the non-participating design. The idea here is simple, the sum assured chosen by the policyholder remains the same throughout the policy term. So if you have bought a non-participating WLA, your sum assured for life (since it is a WLA) will be the same amount. Non-participating designs are more frequently used for protection type policies. They are used for savings type policies too, but this is becoming rare in Singapore.

So why is its name "non-participating"?

Well, the insurer invests your premiums and earns returns on your premiums. When they are pricing the premium, they've already assumed they can earn a certain return on your premiums. This assumption is usually a rather prudent one, i.e. a tad or two lower than what they can genuinely get. In other words, they expect to earn excess returns. "Non-participating" means that the policyholder does not get a slice of these excess returns, when they do happen. How can we see this? Because your sum assured remains the same throughout your policy term. So where do these excess returns go? Them shareholders lah.


This brings us to the second policy design, participating. In this case, the policyholder does get a slice of the excess returns. Every year, the insurer considers its profits for its tranche of participating policies and distributes them between the policyholders and shareholders (ratio is 9:1 by legislation, I seem to recall).

How does the policyholder "get" this profit?

Your sum assured is increased by a certain percentage. This is known as a reversionary bonus, or bonus for short. For example, you've just bought a participating EA of sum assured S$10,000. At the end of the 1st year, the insurer declared a bonus of S$20 per thousand sum assured. That means you will get a bonus of 20*10 = S$200 in sum assured for this policy. From this point on, your NEW sum assured is now S$10,200. If you make a claim in future, you will get S$10,200 and not S$10,000. Bonuses once declared cannot be withdrawn, so that S$200 addition is PERMANENT.

In addition, reversionary bonuses are usually compounding. That means the next bonus declared will be based on S$10,200, and not the original S$10,000. So if one year on, another bonus, this time of S$25 per thousand sum assured, is declared, your sum assured will increase by 25*10.2 (and not 10) = S$255 for a new sum assured of S$10,455.

Participating designs are more popular for savings type products as it is a good vehicle for distributing investment returns. Protection type policies have much lower premiums and therefore little investment returns to talk about (their main profit drivers are better mortality experience than that assumed during pricing). As such, protection type policies, especially the TAs, are usually non-participating.

Note also that for both non-participating and participating product designs, the investment risk remains largely with the insurer. If the asset markets have been doing really badly, they still have to pay out the claims as stated by the sum assureds of the policies. They cannot increase the premium of your policy to counter this. Nor can they decrease your sum assured. So in such cases, they can only bear and grin (usually not so jia lat lah, they should have the reserves to ride out such fluctuations in asset markets).


This is a more recent design, as compared to the previous two. Essentially, your premiums are used to buy into a fund of your choice. This fund may be invested in equities, bonds or cash. It may also be locally, regionally or globally invested. This all depends on the fund objectives. You are awarded a number of units of the chosen fund in return for your premiums paid. The number of units awarded depends on the prevailing price of the fund. For example, your premium is S$500 and the price of the fund is now S$2 per unit. You will then get 250 units.

The fund's price will fluctuate from day to day so the value of your invested premium will also fluctuate. Say a week from now, the value of the fund is now S$1.95, then the value of your invested premium is now 1.95*250 = S$487.50. At the end of the policy term, the total value of your invested premiums will be returned to you.

So where does the insurance part come in? It does look like a pure investment design, doesn't it?

At the onset of the policy, you might get to choose a sum assured. Another possibility is the sum assured is set at some arbitrary multiple of your premium, say 5 times. The unit-linked design is actually quite flexible, allowing for many variants. Whatever the case, this sum assured will attract a mortality charge (may be applied monthly or yearly). Suppose the sum assured is S$50,000 and the insurer charges $$0.60 per thousand sum assured, then the mortality charge will be S$30. This will be deducted from your invested premiums by removing the equivalent from your units. In return for paying this mortality charge, you will get insurance cover for the policy term.

In addition to the mortality charge, you will probably gana an annual (or monthly) administrative charge and fund management charge. Deductions of these operate in the same way as the mortality charge.

Oh, and I forgot to mention the bid-offer spread and/or reduced allocations. Not all of your paid premium will be invested. 5% might be creamed away in the form of a bid-offer spread. This takes the form of quoting the fund price as, for example, S$1.90-2.00. This means, if you buy into the fund NOW, it costs S$2 per unit but if you are selling NOW, it is only worth S$1.95 per unit. Reduced allocation is well, just that, reduced allocation. This is usually done for regular premium paying policies. The insurer might say they will allocate 50% in the first year, 75% in the second year and 100% from then on. This means that only 50% of the first year's premiums you've paid is actually invested. And only 75% of the second's year's. The "missing" 50% and 25% respectively goes to the insurer.

Now if you think about it, the unit-linked design is of greater risk to the policyholder. But this risk comes with the reward of potentially (keyword) higher returns. This risk I'm talking about here is investment risk. For the non-participating and participating designs, the insurer is taking on the risk of poor investment returns, i.e. they still have pay out the full sum assured upon claim and more importantly, at the end of the policy term IF the policy is an EA. For the unit-linked design, the value of your invested premiums is returned to you. Now this depends totally on the performance of the chosen fund. So you can gana jialat jialat if the fund nosedived just before the end of your policy.

However, as mentioned, you do get potentially (keyword again) higher returns for unit-linked designs because the funds usually (keyword) invest more aggressively than when the insurer invests on their own in lieu of the non-participating and participating policies.

It is for these reasons that the unit-linked design is commonly used for savings type policies. I don't think there are unit-linked TAs in Singapore although it is technically possible.

Now collating what I've mentioned here and previously, we have main policy types of the TA, WLA, PE, EA, and AN. These can be of regular premium, limited premium or single premium paying types. From the current post, you should now know there are three policy designs, non-participating, participating and unit-linked. Technically speaking, you can couple any policy type with any premium paying type and any policy design, e.g. unit-linked limited premium paying WLA.

However, as mentioned, participating and unit-linked are more suitable for savings type policies, so we normally see the EA and WLA for these designs (I'm ignoring the PE since it is almost extinct). The TA is almost certainly non-participating. The AN is usually designed as non-participating or participating. It "participates" in the profits by getting annual increases to the regular payments. Haven't seen a unit-linked version of the AN in Singapore yet.

Akan Datang: a surname and a policy design makes a dirty word

214 days to go.


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