Tuesday, August 26, 2008

A fair reduction in yield

If you invest $5,000 for 30 years to earn a yield of 5%, you will receive $332,000 on the end of the period. This is an attractive investment, if the average inflation rate during this period is less than 3%.

If you invest in a life insurance product, you are likely to get an estimated yield of about 2.5%, giving $220,000 at the end of the period. The reduction of 2.5% in yield works out to $112,000 or 34% of the maturity sum of $332,000.

The actual cost of the life insurance protection is estimated to be 5% of the maturity sum. The remaining 29% in charges goes to pay commission to the agent and the expenses and profit of the insurance company.

I consider the reduction of 34% in maturity sum or 2.5% in yield to be too high and that the life insurance policy gives a poor deal to consumers.

A fair deduction should be 20% of the maturity sum, instead of 34%. This is used to provide the cost of insurance protection (5%) and the expenses (15%) for marketing and administration.

A reduction of 20% in the maturity sum over 30 years amounts to a reduction in yield of 1.4%. In the above example, the policyholder will get a return of $266,000 instead of $220,000.

Lesson: if the reduction in yield is less than 1.5%, the policy is giving a fair return (as it includes the cost of life insurance protection). If the reduction in yield is more than 1.5%, the policy is giving a poor deal to the consumer.


Raymond T said...

Hi Mr Tan, what can be done for those whole life policies in force for the past 10 to 16 years as such? =(

Falcon said...

Yes, I have several such policies between 10 to 20 years old. What to do with them now?

zhummmeng said...

The culprit is the insurance agents' commission. Agents are paid too much for doing nothing other than filling up forms and showing and reading the benefit illustration..
Life insurance is supposed to be a noble profession but the insurance agents ate behaving like the "nobles" of Robin Hood time who not only rob the poor but kick them in the side after robbing.They are despicable. MAS must clean up the industry of these agents who are the scourge of society.

Singapore Kopitiam - Voices of Singaporeans said...

For more detailed discussions on these important topics, see:
Singapore Kopitiam

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