When you pay premium for a whole life or endowment policy, a portion (say $X) goes to provide the insurance cover and another portion (say $y) goes towards savings to pay your the maturity benefit or cash value in the future.
The insurance company aims to earn a return of say 5% per annum on the savings portion. However, they take away more than half of the gain to pay commission to the agent, overhead expenses and profit for shareholders, giving a net return of less than 2.5% to the policyholder.
This net return is not guaranteed, as it takes the form of a bonus that can be adjusted by the insurance company.
When the investment return is bad (as has happened every few years), the insurance company cuts the bonus and gives you a lower return. If the investment return is good, the insurance company may not increase the bonus, as it prefers to keep the excess gain as "orphan money" in the insurance fund. The policyholder is likely to lose out in the long run and get a return lower than projected.
After deducting the cost of insurance (i.e. $X) the net return may be less than 1% per annum. This is a poor return for a long term savings plan.
This very low return is possible only if the policy is maintained for more than 15 years. If it is terminated earlier, the cash value is likely to be less than the total premiums paid, giving a negative return to the policyholder. Many policyholders lose more than half of their savings on early termination.
To give a fair return to the policyholder, an insurance company should follow this approach:
a) reduce its expenses, especially commission to agents
b) distribute most of its investment gain to policyholders
Unfortunately, to my knowledge, none of the life insurance company in Singapore follow this approach.
Hence, it is best to avoid all types of life insurance policies that have high expenses. Buy term insurance for the life insurance. Invest your savings in government bonds or an exchange traded fund.
Tan Kin Lian
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