Managing personal risks

A working person faces the following risks:

a) premature death

b) serious illness and disability

c) unemployment

d) insufficient income during retirement

The chance of (a) and (b) occurring during the working life is quite low, perhaps less than 5%. By getting bad advice from insurance agents, they spend too much of their savings to insure against these risk.

Most people (i.e. 95%) are likely to face the risk of (c) and (d). This risk can be best managed through personal savings. The savings should be invested to earn a good rate of return and can be withdrawn without penalty, e.g. through a low cost investment fund.  The personal savings can be used to cover cash flow needs during a temporary period of unemployment, without the need to depend on borrowings which incur a high interest burden. If the savings are invested prudently, they will provide an adequate amount for retirement.

Many investment products offer a poor yield of 2% per annum. By investing on their own in a low cost investment fund, they can get a much higher yield, for example, 5% per annum. The difference in yield is taken away in distribution cost and other charges by the financial institution.

Here is the difference in the accumulated amount at the end of 35 years from a monthly saving of $500.

Interest     Accumulated     %
rate             savings
2%           $306,000     100%
3%           $374,000     122%
4%           $460,000     155%
5%          $569,000      186%

Many people invest their hard earned savings in a life insurance policy to earn a net yield of 2% per annum. If they invest on their own in a low cost investment fund, they may be able to earn a higher yield, which could potentially give them 86% more.

They only need to spend 5% of their savings to buy a low cost decreasing term insurance. If this is taken off $569,000, they will still get a net balance of $540,000, which is still much higher than $306,000. They will accumulate sufficient savings in 20 years - so the insurance becomes less essential.

As an alternative, they can also buy a personal accident insurance for $300,000 at a premium of about $200 a year. Most of the risk of premature death is caused by accident.

Summary: the key priority is to have adequate savings (say 15% to 20% of your earnings, in addition to CPF) and to invest it in a low cost insurance fund to earn an adequate rate of return. Spend not more than 5% of your savings on term or personal accident insurance.

Tan Kin Lian

Do not accept a poor deal

Dear Mr Tan,
Thank you for your good advice; I have learnt much from your blog and your Practical Guide on Financial Planning. It is really useful! Now I have a small but decent portfolio of ETFs and individual company stocks.

When I graduated, I was not savvy enough and bought 2 policies. Based on your book, I have analysed them as follows: 

Policy 1 shows effect of deduction contributing very high, about 27.8% in year 25 of policy, but drops drastically to only 3.4% during maturity in year 28 of policy. Sounds too good to be true? What is the loophole?.

Policy 2 (ILP) shows a ridiculous low projected return. I would be better off just buying term insurance.

However, I remember you mentioned that distribution costs are mostly incurred in first 2 years. Since we have paid them, should as well continue. Is this still the best way to go? 


REPLY

For Policy 1, a large part of the projected value at maturity on year 28 is non-guaranteed. It is difficult for the policyholder to be sure that this non-guaranteed portion will be paid, especially if it shows a big jump compared to the non-guaranteed value in the earlier years. If the company give some reason at that time to be unable to pay the non-guaranteed value, or to pay less, what can you do?

For Policy 2, the effect of deduction is more than 50% of the accumulated premium. Although you have already paid the upfront distribution cost, it seems that you will continue to suffer a large loss each year due to the "effect of deduction".

I suggest that you take the following approach:

a) Ask your insurance adviser to explain the above two points to you, and address your concern.

b) If you do not get a satisfactory explanation, write to the insurance company

c) You may to lodge a complaint to MAS about the type of policy that you have been misled into buying (i.e. you would not have bought these policies if you knew what they really were). 

d) Write to the newspaper.

Do not allow people to sell you a bad product, and you have to suffer the uncertainty and poor return for a lifetime.

Postings on Benefit Illustration

I have made over 20 postings about the benefit illustration that comes with a life insurance policy. I have collected them together under the label "Benefit Illustration" shown on the right. I urge consumers to follow my tip and understand what to look for in the benefit illustration.

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

Terminate a Revosave policy

Hi Mr Tan,
I need you advice. I have a friend who bought Reovsave last November. She paid the premium in full for the year. I am thinking if it is better to terminate the plan and do investment for the rest of 25 years. What do you think?

REPLY
Ask her to send the benefit illustration for me to talk a look. But, it could be quite complicated to analyse. I will try and see what the "effect of deduction" is for this policy.

Maybe, one way of looking at this question is to see the distribution cost. If the premium paid is less than the distribution cost, it would be better to terminate the policy and save on the balance of the distribution cost.

Benefit Illustration of new plans

Dear all,

Below are the benefit illustration and policy summary for the 4 newer products since 2008 for ntuc income. They are all based on 30 yr-old male customer. Do note that all figures are projected and "hope for the best", unless stated unequivocally as Guaranteed.

1.  Vivolife $100K sum assured & pay for 20yrs

2.  Revosave $50K sum assured & pay for 25yrs

3.  Sail $50K single premium & tenor of 30yrs

4.  Vivolink regular ILP $500/mth


Consultant

Yield on life insurance policies

A consumer sent me the benefit illustration for three plans. I have calculated the yield to be as follows:

Plan	Term	Yield p.a.	Reduction in yield
Growth - single premuim	5 yrs	2.94%
Growth Link (AIM) - single premium	30 yrs	3.52%	1.73%
Revosave - monthly premium	15 yrs	2.82%	2.43%

The return on the growth plan is fairly  satisfactory.  The return for the other two plans are not attractive, considering the duration of investment. The are based on a projected yield of 5.25%. If the actual yield is lower, the yield on the policy will be lower than illustrated.

If you are investing for 10 years or longer, you should aim to get at least 4% per annum.

Tan Kin Lian

Benefit Illustration - distribution cost and effect of deduction

A consumer ask my advice on a new product that is being sold to her. It is a life insurance policy with the benefit paid in installments over a period of years (similar to a life annuity). She sent a 15 page benefit illustration on this product to me. She was confused with the explanation by the financial consultant.

I find it difficult to understand the product based on the benefit illustration. There are a lot of information, including items that are not related to the product itself. The additional information gives opportunity to the financial consultant to mislead the consumer when she explains the product.

The distribution cost was $14,000 and there is a statement "please note that the distribution cost is not an additional cost to you, it has already been allowed for in calculating the premium". I find this statement to be misleading - it is a cost paid by the consumer and is a lot of money for financial advice that is confusing and detrimental for the consumer.

 I found the "effect of deduction" after 30 years to be horrendous. Based on projected investment yield of 5.25%, the accumulated premium amounts to $840,000, effect of deduction is shown as $611,000 (73%) and the amount payable to the consumer is $231,000 (23%).

What kind of financial product takes away 73% of the accumulated savings from you and leave you with only 27%? I do not know if these figures have been calculated correctly, but they appear in the benefit illustration.

I have advised that the "effect of deduction" should not exceed 20% for most types of long term products. I complained when the ratio is 40%. Now I have seen a ratio of 73% for this product. It is tantamount to daylight robbery and cheating of unwary consumers.

Perhaps the Monetary Authority of Singapore should contact me so I can ask the consumer to send the  benefit illustration for their study. This type of product should not be allowed to be sold to consumers, as they are clearly unfair. Perhaps the benefit illustration should be changed, so that it contains information that is clearly understood by the consumer, without giving opportunity for the financial consultant to mislead the consumer through verbal explanation.

Tan Kin Lian

Mortgage Protector from Aviva

Dear Mr Tan
I would appreciate if you can review the above insurance plan for me. (Attached are two benefit illustrations for the Morgage Protector plans from Aviva).

REPLY
I compared the monthly premium with the benchmark premium (for decreasing term insurance) shown in my book, Practical Guide on Practical Insurance. I find the premium rate charged for Aviva for the Mortgage Protector policy to be reasonable.

However, if I were in your shoes, I would probably buy the Mortgage Protector only, without the Critical Illness Accelerator, as the additional premium of 80% does not seem to be worth paying.

You can buy my book here.

Replacing a whole life policy

When an insurance agent approaches you to tell you that a new policy is better and advise you to give up an existing policy to convert into the new policy, the insurance agent is 99% likely to be cheating you. Do not believe the agent.

Ask the agent to give you a benefit illustration and send it to me at kinlian@gmail.com. I will point out on where the agent has been misleading you, and how much you would lose in your savings by taking this type of advice. It can cost you a few thousand dollars.

One common practice is to replace a whole life policy by a policy with premium paid for 20 years or shorter. The customer does not know that he has to incur a hefty upfront cost  a second time. The premium for the shorter period is much higher than a whole life policy. Further more, the existing whole life policy has an option to covert into a paid up policy at any time, i.e. the policyholder retain the flexibility to stop the policy at any time (but the agent does not explain this option to you).

If you are buying a new policy, you can decide on whether to buy pay a lower premium for a lifetime, or a higher premium for a shorter period. (Frankly, both options are not good for consumers, due to the high upfront cost). But, you should NEVER stop an existing whole policy policy to move into a new policy, as you will be incurring a large cost for the second time.

Tan Kin Lian

Buying a life annuity for a parent

Dear Mr Tan,
My father is going 58 and has  only $30,000 in his retirement account. I was thinking of helping him to purchase either the NTUC Income Classic Annuity or the Growth Plan.

Since both plans require a SRS account, I thought of buying a Growth Plan for my Dad using his retirement account to earn a get a greater return, by registering with one of the SRS operators and subsequently use this SRS account of $29K to buy Growth Plan.

Can I do that? I am not sure because I understand that there is a so called minimum sum required in RA and RA cannot be used to buy anything except annuity.

REPLY
The money in the CPF Special Account (or Retirement Account) now earns interest at 4% plus a bonus. The return from the Growth plan is likely to be 3% or less. The agent who made this recommendation is probably giving bad advice, either intentionally or by mistake.

Please ask the agent to give you a benefit illustration for the Growth plan and send it to me at kinlian@gmail.com.

It is better for you to help your father by topping up his CPF Special Account. You will enjoy tax savings on the contribution and allow him to earn a higher rate of return of 4%. When he reach age 62, it is better for your father to buy the CPF Life, instead of a life annuity from an insurance company.

You can read a chapter on life annuity and CPF Life from my book, Practical Guide on Financial Planning, which can be ordered here:

Transparency in life insurance

A life insurance policy provides two useful services:
a) insurance against premature death
b) investments of savings for the future.

For the first service, the consumer wants to pay a fair price. The consumer does not want to be overcharged,compared to similar insurance offered by other providers. For the second service, the consumer wants to get a fair yield, comparable to the yield that can be obtained from other investments with similar risk profile.

A good insurance policy is transparent and give good value to the consumer. Unfortunately, there are many life insurance products that are not transparent and give poor value to the consumers. It is difficult for the consumer to distinguish between the good and bad products.

The benefit illustration for the insurance product can give some indication about the fairness of the charges and the yield. Look at the distribution cost, which is the amount that is taken from your savings. If it is $1,000 or more, it seems to be excessive. Do you really want to pay such a high fee to the insurance agent, who may be someone that you do not know previously? This fee is taken away from your savings, which is the same as being paid directly.

You can also look at the "effect of deduction". This is the total amount that is taken away from your "accumulated premiums" during the lifetime of the policy. If this amounts to a high percentage of the accumulated premiums, then you are being offered a policy of poor value.

I have written a separate article about the the percentage that is fair, and the percentage that is excessive. If you are not sure, you can write to me at kinlian@gmail.com. I can answer you directly or refer you to FISCA, www.fisca.sg

A life insurance policy can represent a large part of your future savings for a lifetime. Make sure that you get a fair deal and a good yield. Make sure that you are being advised by a honest agent who takes care of your interest (and not his own personal gain). Do not make a bad investment that will penalise you for a lifetime.

Tan Kin Lian

Distribution cost

The benefit illustration for a life insurance policy has an item called "distribution cost". This is the amount taken away from your savings (i.e premiums) to pay the commission to the insurance agent and his agency manager. It is usually a large sum of money, representing more than 18 months of premium. If you save $500 a month, the amount that is taken away as distribution cost could be (say) $9,000.  A large part of this sum is taken away during the first year and the rest over the next four years.

You should ask, "Is it too much to give away (say) $9,000 to buy a life insurance policy? You have more attractive alternatives. You can buy term insurance to cover a larger sum (say $300,000) by paying less than $500 a year.  You can invest in a low cost fund, such as the Exchange Traded Fund in SGX, and pay only a small annual fee of 0.3% for the asset management service.

If more consumers are aware about the alternatives, there is no need for them to pay 18 months of their premium as "distribution cost". This will force insurance companies to reduce their distribution cost and find more efficient and low cost ways to market their products. Some countries plan to ban the payment of commission for the sale of insurance products, as the consumers had been given a bad deal for the past years.

After paying such a high distribution cost, you are not getting a superior product that gives superior return. Most life insurance policies give a yield of 2% to 3% over 30 years. This is too low. It should be higher, if the distribution cost and other charges are kept at a modest level.

However, if you find a life insurance policy that has a modest distribution cost, say $300 or less, it is all right to buy the product. Alternatively, you should be willing to pay a fee of $300 for advice, provided that the commission built into the life insurance policy is refunded to you.

Tan Kin Lian

Effect of Deduction

An agent who recommends a life insurance policy to you is required to provide a benefit illustration, which can take 10 pages or more.

You should ask the agent to show you the "effect of deduction" and calculate it as a percentage of the "value of premiums paid". The "effect of deduction" should not exceed the following percentage of the "value of premiums paid" in the case of a regular premium policy:

20 year policy - 15%
25 year policy - 18%
30 year policy - 22%
35 year policy - 25%

The above benchmark is my estimate of the fair amount to be deducted from your "value of premium paid" to cover the insurance protection and investment services provided by the insurance company. If the actual percentage is higher, the amount taken away is excessive.

The "value of premium paid" is the accumulated amount assuming that your premium has been invested to earn the assumed rate of return. The "effect of deduction" is the amount that is taken away from your accumulated amount to cover the charges by the insurance company.

Most insurance policies have an "effect of deduction" that takes away an additional 15% from the accumulated premiums (compared to the reasonable levels shown above). These insurance plans do not provide good value to consumers.

For an investment-linked policy, the "value of premiums paid" is not shown. You have to add the "projected net amount" plus "effect of deduction" to get the "value of premiums paid".

Tan Kin Lian

Get the Benefit Illustration

Someone asked my views about the SAIL policy that is capital guaranteed. I do not know the features of this policy. I ask her to send the benefit illustration to me. I recall reading some negative comments about this policy but I do not know why.

Agent tried to sell high cost insurance policy

A consumer wanted to buy a Term Insurance policy under a Family Policy. She approached an agent who recommended a Whole Life policy (Vivolife), on the argument that the Whole Life policy provides a return on the premium. The comparison is not made on a fair basis, and the consumer was confused.

I asked the consumer to send the benefit illustration to me. I found that the Whole Life policy had a high "effect of deduction. The amount deducted represented more than 40% of the accumulated premiums - which is too high. Why should a consumer give away over 40% of the accumulated value of the savings to the insurance agent and to the insurance company?

Many consumers are still being given bad advice by insurance agent. To get an idea about the premium that you should be paying for Term Insurance, go and visit this website in America.

Tan Kin Lian

Misleading illustrations

Some life insurance products were designed to provide an annual cash bonus. The underlying return on the policy is poor, usually less than 2% p.a., due to the high expenses and profit margin. To enjoy the cash bonus, the consumer has to pay an additional premium that is usually more than 10% of the cash bonus. For example, to get a cash bonus of $2,000, the additional premium could be $2,200 a year. The consumer is not aware about this type of structure.

To hide the poor return, the insurance agent tells the customer that the cash bonus can be re-invested in an investment linked fund to earn 5% or 9% per annum. This is stated to be not guaranteed, but the consumer does not know that the projections are over-optimistic.

By illustrating with this high projected return, the benefit illustration will show a higher return on the policy, perhaps 4% or more. If it was possible to earn 9% per annum, the consumer should invest the entire premium into the investment linked fund, rather than just the cash bonus.

I hope that the authority will ban this type of projection, as it is misleading to the consumer.

Tan Kin Lian

Benefit Illustration - Single Premium Whole Life Policy

I analysed the benefit illustration for a reader of my blog. The figures have been changed or removed to protect the identity of the policyholder.



1. You are investing a single premium of $30,000 in a life insurance policy. The distribution cost represents 7.9% of the invested sum. This is high, but it is typical of life insurance policies (where a high commission is paid to the agent).

2. If you decide to terminate the policy within 5 years, you will get a cash value that is less than the single premium. This policy, like all life insurance policies, provides poor liquidity. You cannot withdraw your investment without suffering a high penalty. As may need to withdraw your investment to meet some unexpected cash need in the future, it better to have the flexibility, especially in an uncertain world with insecure employment.

3. Here is the projected yield on your investment. If you keep the investment for 30 years, you are guaranteed a minimum cash value which represents a yield of 2.33% p.a. If the insurance company is able to earn an average yield of 3.75% on its investments in the future, they projected a non-guaranteed payout which a yield of 3.1% p.a. If they earn 5.25%, the non-guaranteed payout represents yield of 3.96% p.a. These yields are reasonable, but not attractive.

4. If you decide to invest on your own in an exchange traded fund, such as the STI ETF, and you receive an average yield, net of charges, of 5.25% over 30 years, your investment would accumulate to an amount that is 45% more than the non-guaranteed cash value provided by the life insurance policy at the end of 30 years.

5. I usually recommend to young people to learn about managing the risk of long term investments. After they understand the risk, they would usually prefer to invest in an exchange traded fund (which offers diversification of risk) and a potential better return. They will face short term fluctuation, but they understand that the fluctuation does not really affect the long term value of their investment.

6. You are offered an option for you to buy a rider that will accelerate the payment of the sum assured when you contract one of the critical illness. This “acceleration” means that the sum assured is payable earlier, rather than being paid on death. However, there is an additional cost for this “accelerated payment”. I think that the chance of making a claim is quite low, and this cost is rather high. But, I do not have the statistics to know if it is worth paying this additional premium for the accelerated benefit.

Tan Kin Lian

Switching a policy will incur high front end charge

Dear Mr Tan,
I would really like to seek your comments regarding a single premium whole life policy introduced to me after realizing that my endowment and whole life policies were not worth keeping. A financial adviser recommended me a 25 year whole life plan to replace my existing policies and I asked for a 'single premium' quote on the same plan. Attached is a copy of the BI. May I seek your advice if this policy is acceptable because I’m very confused

REPLY
It is usually a bad idea to switch from one policy to another, as you have to incur the upfront cost again, and this will give good commission to the insurance agent. Generally, I would advice people not to make such a switch, unless there are clear advantages of doing so.

If you are not able to trust the agent who is making the recommendation to you, you should not buy the new policy from the agent.

I am not able to study your case in detail. If you wish to get advice, you can contact FISCA. They will get a volunteer to asssit you to understand the benefit illustration but you have to pay an admin fee of $50. You can contact FISCA at www.fisca.sg

Get the Benefit Illustration

A few people have asked me quite difficult questions on the life insurance policies that have been marketed to them. They ask, "is it all right to invest in the policy?"

Quite often, the policies are specific to the company that has offered it. I am not aware about the features of the policies, or the charges that are being taken away from the premiums that have to be paid. I know that, in most cases, the charges are excessive and the insurance policy represents a bad investment for the consumer, but I am not able to give a conclusive view, without the underlying facts.

My reply to the consumer is, "get the Benefit Illustration and send it to me". With the Benefit Illustration, I can point out the key points in the policy and how consumers are being overcharged, or "ripped off".

A few consumers who sent their Benefit Illustrations to me in the past were shocked that a large part of the potential investment gain was taken away from them, and this was not explained by the financial adviser who sold the policy to them. When they learn about it, it was already too late.

If you want my views, send the Benefit Illustration to me.

Tan Kin Lian