## Wednesday, March 17, 2010

### Life insurance - effect of deduction

When an agent tries to sell you a life insurance policy, he (or she) is required to give you a benefit illustration. It is a detailed document comprising of more than 15 pages and contain a lot of confusing information. You only need to look for 1 figure - "effect of deduction" at the end of the 20th year. Calculate this amount as a percentage of the "accumulated premium". If this percentage exceeds 15%, you should avoid the policy. For example, if the effect of deduction is \$25,000 and the "value of accumulated premium" is \$100,000, the effect of deduction is 25%. As this is higher than 15%, you should NOT buy the insurance plan. In this example, you are paying \$10,000 more than is fair to the consumer.

For investment linked plans, you are not given the value of accumulated premium. In this case, you have to add up the "total cash value" with the "effect of deduction" to get the "value of accumulated premium. Take the figures based on 5% projection (as 9% is unrealistically high). If the total ash value is \$100,000 and the effect of deduction is \$30,000, the "value of accumulated premium is \$130,000 and the effect of deduction is 23%, which is too high.

Do not invest in any insurance policy, where too much of the accumulated premium is taken away from you. It is your money, and you deserve a fair rate of return for your years of hard work and savings. Do not give it away. Buy a term insurance for 25 years and invest your savings in a low cost investment fund, such as the STI ETF, Read about this concept in my book, Practical Guide on Financial Planning.

Tan Kin Lian

Anonymous said...

I think your formula is confusing.

The word you used "effect of deduction" is confusing. what kind of "effect"? what is "deduction"? why 15%? how to justify? Does it change with time? Very confusing.

To me, it's KISS - "Keep it simple, stupid!" Just use total distribution costs vs total premiums paid. KISS!

Anonymous said...

KISS.... LPPL, lah
effect of deduction means the effect after deduction....KISS, lah...LPPL

Anonymous said...

Hi, I would like to know how do you justify the 15%?

Currently, the life insurance that they have comes with 2 figures. One with projected 3.25% and the other with 5.75%. From with figure do we compare it with?

avint said...

HI
Such a nice Post

Life Insurance

TengHui said...

Dear Kin Lian,

After reading your tip on how to assess policies by looking at Effect of Deductions as a percentage of Accumulated Premiums, I'm so pissed with my PruLink Protection Account now! In my Benefit Illustration, at Year 20, at Projected Investment Rate of Return = 9%, Cash value = \$33,600, Effect of Deductions = \$33,317 (This EOD is for 9% returns. EOD for 5% returns is not shown in the Benefit Illustration). Hence Accumulated Premiums = \$66,917, and Effect of Deductions (EOD) = 50%!!! This deal is way more costly than your recommended good deal with cost of 15%, or even your example of a poor deal with cost of 23%!

I feel outraged. I'm paying \$148/mth (\$100 for Death coverage and \$48 for other riders), and I'm currently 2 years 3 months into my policy. The Benefit Illustration says that I can expect cash value of \$400 after 2 years of 5% returns, and I know the funds have been seeing returns of more than 5% because Prudential’s annual fund reports say so. However my cash value is currently \$0 (instead of \$400)! It is because of this discrepancy in expectation that spurred me to spend 2 days to pore through all the ILP documents, and as a result, I just became savvy that the Benefit Illustration is not based on the actual premium allocation. My actual premium allocation is 15% for 1st year, 50% for 2nd-3rd year, 100% for 4th – 9th year, and 105% from Year 10 onwards, whereas the Benefit Illustration is based on premium allocation of 100% every year. It just doesn’t make sense to me why the Benefit Illustration is not based on the actual premium allocation. It should not be difficult at all for Prudential to implement the correct premium allocation figures into the Benefit Illustration so as to project the correct cash values. If the Benefit Illustration doesn’t even attempt to give an accurate picture, then I really don’t see much use for it as an illustration of benefits.
With the new awareness that my ILP has extremely high costs of 50% at 20 years, what is my best course of action now?