Friday, September 02, 2005

Life Insurance III - My Opinions

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

If you've heard of the saying "buy term and invest the rest", actually know what it is referring to and WHY it is so, then you can basically skip the main part of this post and just read the last bit on annuities. If not, "enjoy".

Many Singaporeans (not sure if it is a global phenomenon) are fixated about earning a return on their premiums paid. So EAs and to some extent, WLAs, are very popular products. Not only that, the unit-linked variants of them are particularly hot-sellers as they give higher expected (keyword) returns.

There is another reason why EAs are so popular. The commission that insurance agents get is a percentage (keyword) of the premiums received by the insurer. Since premiums of EAs are the highest (not considering the AN), it is small wonder that agents will push to sell EAs more than the other products. And of course, they will tend to neglect the TA since its premiums are the lowest. The TA in Singapore is like some poor and lost cousin, few people bat an eyelid at it.

Now, let's go back to my previous point on the fixation on getting returns. Take a step back and ask yourself, what is the purpose of buying insurance? Is it to earn a return or is it to protect yourself/your family against some contingency? Many people start the process of buying insurance with the right frame of mind but some way done the line, they get sidetracked, attracted, mesmerised by the possibility of getting something back in return for their premiums paid. That is so wrong. Insurance is about getting protection, not making money. Indeed, the very idea of insurance was invented as a means of spreading risks amongst a large group of people so that the financial blow from any loss, when it happens, is softened for those unfortunate enough to be afflicted.

So my first point is, you're buying insurance primarily for the protection, earning returns is secondary.

Now if you want to earn decent returns on your monies, there are many much more effective means of doing so than via insurance. Why and how?

If you're getting a non-participating or participating EA, then your returns will certainly not be spectacular. The insurer has to invest somewhat prudently to be able to meet your guaranteed benefits, and remember, payout of these benefits is imminent for the EA. By "prudent", I mean they invest a large percentage of your premiums in safer, less risky assets like cash.

Another point, a much more important one, is the commissions that your premiums get hit with. This happens regardless of the policy design and premium paying types. As a guide, consider a unit-linked single premium EA. At the minimum (keyword), your premium will gana the bid-offer spread of 5%. There may be other initial costs, such as a reduced allocation. You can easily invest in a similar unit trust with similar fund objectives that attract half that initial cost. Or less. You might say only 2.5% difference mah. Well, let's see its impact with an example.

Let's say you invest S$20,000 in a fund for 20 years and it managed to earn an annual return of 6%. I ignore all other costs (I'm referring to those annual ones). For initial cost of 5%, you will get 19,000 * 1.06^20 = $60,936. if the initial cost is just 2.5%, you will get 19,500 * 1.06^20 = S$62,539. That's a difference of over S$1,600 in 20 years time.

Similar costs occur for participating and non-participating products. It is just "hidden" from you. "Hidden" in the sense that the insurer do not need to report to you how many units you have with them unlike the unit-linked products. "Hidden" in the sense that the amount you get back at the end of the day is already net of these costs.

Or an even better alternative, provided you have the expertise and large sums of money, enter the equities (stocks and shares) market on your own. Or other asset markets like bonds. The initial transaction cost will be even lower (less than 1% for the stock broker). BUT (big big keyword), do so with your eyes WIDE OPEN and do your research beforehand. If not, just stick to unit trusts.

So my second point is, if earning returns is your primary objective, you're looking for it at the wrong place.

All this discussion thus far brings us back to that saying I quoted right as the beginning, "buy term and invest the rest". Get it now?

OK, so what life insurance do I need then?

If you are asking me this question after reading the above, it means you haven't read Life Insurance I and Life Insurance II. Or you haven't paid attention whilst reading them. But I'll still spell out the answer here. You need protection type policies. That's mainly the TA and AN, and to a certain extent, the WLA. The extent of how much of each you need, is another story altogether and one I cannot answer without knowing more about your circumstances (this is not an invitation for you to e-mail me your details and ask for a specific recommendation).

The TA provides protection for your dependents from the loss of your income should you pass away during your productive working life. Unless you have no dependents, this should really be a basic component of your portfolio BEFORE you even think about investments.

Now it would be ideal if the sum assured could increase and keep pace with inflation but the TAs in Singapore are all non-participating, i.e sum assured is fixed. However, there is also an opposite effect to sort of balance that off. The potential loss of income, and hence the need for coverage decreases with age as your effective working life decreases. Actually, this latter effect overwhelms that of the former, so an average person would actually have a smaller need for death coverage as one ages.

There is actually a variant of the TA to cater for this need for decreasing coverage. It is called the Decreasing Term Assurance (DTA). The sum assured for the DTA decreases from an initial amount to zero over the policy term. Needless to say, the premiums for the DTA is even cheaper than the TA.

One strategy I've seen is to couple the TA with the DTA so that you are guaranteed a certain minimum level of coverage throughout the policy term but the overall coverage still decreases as one ages.

The other possibility is to just get a participating (keyword) WLA. This is quite a common product in Singapore. The participating part affords an increase in sum assured that broadly mirrors inflation. The WLA is still largely a protection policy, so premiums are still not too expensive (but are still more than that of the TA). During the younger ages of the policyholder, it protects the dependents in the same way as the TA. During retirement ages, it can help pay for estate duties when one passes away or even leave behind a legacy for your children.

Now, I've been neglecting something else that is very important for protecting yourself at old age. The AN. Most Singaporeans do not buy ANs upon reaching retirement age, although it provides for the most important type of coverage needed at that point in time. No, not death (go read Life Insurance I again!) but longevity. Indeed, this neglect of the AN is a global phenonmenon. Other than the USA, most other countries see little volume in AN sales. Perhaps it is because of the feeling that this is being selfish. That "I am not leaving any legacy for my children" feeling.

Indeed, it is the act of NOT getting an annuity upon retirement that should be deemed as selfish. Without the AN, you will be creating fear and pressure for both yourself and your children that your own savings will not be enough to sustain yourself for the remainder of your life. By getting that AN, you will remove this fear altogether. If you still feel the need to leave behind some form of legacy for your next generation, you can always choose to not spend all your savings upon retirement on the AN. By all means, set aside part of it as your legacy.

Oh and by the way, participating ANs do exist in Singapore. So the income stream you receive during your golden years will be protected against the forces of inflation.

So my third and final point is, the TA, the WLA to some extent, and the AN, this upon retirement, are the main product types we can all do with in our portfolio. After getting these, invest the rest of the savings elsewhere but NOT in an EA. As to where to invest, this is not the objective of this post.

Take note that we've been discussing Life Insurance all this while. I have not mentioned something equally vital yet. Health Insurance. With Life Insurance policies, we've protected our dependents from the unfortunate event of our premature death and the not so unfortunate event of our longer than expected longevity. Health Insurance is for circumstances when we fall ill. Loss of income? Medical fees? Nursing home expenses? I'll cover these in future posts once I find the time to do so.

In closing, I note a recent positive development in the sales of insurance products. There are now many agents who are licensed to sell not just insurance products but unit trusts as well. So they don't just represent the insurer, but some investment houses as well. This is a good development as the sales agents will now have a wider repertoire of investment and insurance instruments to pick from. They can then recommend to the client a cheaper way to constructing a suitable investment portfolio.

Akan Datang: 鴨鴨

210 days to go.

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