Giving up an existing investment-linked policy

Dear Mr Tan,
I currently have an investment link life policy. I calculate my loss to be $6000. I decide to surrender this policy and take up term insurance. Is my decision to surrender this policy a wise choice? Should I buy the term insurance from Aviva or NTUC?

REPLY
Normally, it is better to continue an existing policy, rather than to terminate it, as you have already incurred the upfront cost. However, you should look at the continuing cost, before you take your decision.

I suggest that you ask both Avivia and NTUC Income to give you a quote for the term insurance. You can compare the premium rates and make your decision based on the facts.

You can get more guidance from my book, Practical Guide on Financial Planning. It can be bought here:
http://projects.easyapps.sg/iShop/public/common/Order.aspx

Switching between guaranteed and investment linked returns

Over the past years, insurance agents have earned high commissions by getting their policyholders to switch from guaranteed to investment-linked returns and back again.

When the stock market is hot, they tell their customers to move to investment-linked returns by enticing them with high projected values (which were not guaranteed). When the stock market fell, they tell their customers to move back to guaranteed returns.

Each time that the customer took the advice to make a switch, the insurance agents earn a high commission on the new policy that was sold. The customers were not aware that they were exploited and given poor financial advice. They were "taken for a ride", time and again.

An ethical agent will advice the customer to stick to the existing policies. They can invest additional savings in the new policy, rather than move the entire savings from an existing policy to a new policy.

If you have been misled by an agent using this technique in the past, you can send an email to kinlian@gmail.com

Tan Kin Lian

Switching to a limited payment whole life policy

In the past, many people bought a whole life insurance policy. It provides life insurance cover for the whole of life and requires the premium to be paid for the whole of life. It has an option for the policyholder to terminate the policy and receive the cash value, or to stop the premium payment and receive a paid up value (payable on death). This option is usually exercised at an older age, when the policyholder has retired from work.

Take a hypothetical example. The policyholder insures for $100,000 and pays an annual premium of $2,000. After 30 years, he can terminate the policy and receive a cash value of (say) $75,000. Alternatively, he can stop the premium payment and continue the policy for a paid-up value of (say) $95,000, inclusive of bonus. The paid up value is payable on death.

Some insurance agents are unethical. They approach their existing policyholder and tell them that their company has introduced a new whole life policy that requires to be paid for only 20 years. They advice the policyholder to terminate an existing whole life policy and take up the new policy. They did not tell the policyholder that the existing policy already has the option to convert the policy into a paid up policy at any time.

If the policyholder is presented with a proper analysis of both options, the policyholder would have found that it is better to continue with the existing policy. However, the policyholder is usually presented with misleading advice to switch to the new policy. This bad advice is in the self-interest of the agent and is against the interest of the consumer. The insurance agent is able to earn a large commission  on the new policy that has been sold.

If you have been given this type of wrong advice, you can write to me at kinlian@gmail.com

Tan Kin Lian

Existing Life Insurance Policies

A few people have asked for my views on whether they should continue their existing life insurance policies, as the return is rather poor. I asked them to read this FAQ and get the relevant figures to make a decision.

Generally, it is better to continue with the existing policy. You have already incurred a high upfront cost during the first few years of the policy, which gave you a bad start. But, excluding the upfront loss (which you have to write off), the going-forward return should be better, maybe 3% to 4% per annum, compared to alternative investments.

Never give up an existing policy to buy a new life insurance policy. You will incur the upfront cost again. My insurance agent will tell you that a new policy is better. This is bad advice. It is also unethical, as they are earning a large commission again, at the expense of the client. This is called "twisting" and is illegal in some countries.

Tan Kin Lian

Purpose of insurance regulations

Some regulators consider that their primary duty is to ensure the solvency of the insurance companies, as financial failure will cause hardship to the consumers. Solvency is important, but is not the only risks faced by the consumer.

The regulator has also to pay attention to all four duties, as follows:
- Maintain insurer solvency

- Compensate for inadequate consumer knowledge
- Ensure reasonable rates
- Make insurance available

Consumers are not well versed in insurance and may be badly treated through legal contracts that are not transparent and not fair. A common example is the use of irresponsible projection to entice consumers to invest in insurance contracts, and to give a final payout that is much lower than projected. Badly worded or unclear language in policy documents also place consumers at a disadvantage as the consumers are not able to afford the legal fees to have the contracted interpreted in the court.

The regulator has also to ensure that the insurance rates are reasonable and that consumers are not overcharged due to their ignorance of the market or their inability to judge the value of the insurance protection that is provided.

At the other extreme, the regulator also wants to prevent irresponsible price cutting that may lead to insolvency of the insurers. If an insurer cuts price to an inadequate level, other insurers may be forced to follow, to protect their market share.

The regulator also aims to ensure that insurance is available, especially for people or risks that are considered to be unprofitable. As motor insurance is compulsory, it is necessary to ensure that it is available to people who are considered to be high risk, as they would otherwise by denied the right to drive a car.

Tan Kin Lian

Policy wordings

In many states in America, the policy wordings used by insurance companies have to be approved by the regulator. I find this to be a good practice. The regulator can check that the wordings are clear and are fair to consumers. It will minimize disputes that have to be resolved in court. It is also a good practice for insurance companies to use standard wordings for the common types of coverage, rather than be allowed to write their own wordings.

I hope that this practice can be adopted in Singapore and that the regulator can play an active role in achieving this outcome - to ensure fair treatment of consumers.

Tan Kin Lian

Fair settlement of claims

Many claims officers think that their responsibility is to reduce the claim payments and save money for the insurance company. They may not be aware that they also have a duty to ensure fair settlement of claims. Some states in America have laws that forbid unfair claim practices, such as:


–Refusing to pay claims without conducting a reasonable investigation
–Not attempting to provide prompt, fair, and equitable settlements
–Offering lower settlements to compel insureds to institute lawsuits to recover amounts due

This is taken from the text book that I use to teach Risk Management & Insurance at a local university.

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

Big cut in maturity payment

A policyholder bought a 21 year anticipated endowment policy. At that time, the policy showed a projected return of 5.5% per annum. The company used 7% to project the accumulation of the triennial payments and also included reversionary and maturity bonus that were not explained in a transparent manner. However, the company did explain that the projected amounts were not guaranteed.

On maturity, the policyholder was given a payout that is about 35% lower than the initial projection. The final yield was reduced to 1.6% per annum. The insurance company explained that the low payout was due to the difficult investment climate. In my view, this is only partly true. Another major contributor was the highly optimistic assumptions used in the initial projection, to entice the consumer to buy the insurance policy.

I hope that the authority will ask the insurance company to be accountable for its initial projection. While it is acceptable for the final payout to be lower to reflect the actual investment climate, the difference should not be as much as 35%. I believe that this type of unfair treatment applies to large numbers of policyholders.

I have advised consumers not to trust the optimistic projections that are used to sell life insurance policies, unless there is a higher standard of business integrity and protection of consumer rights.

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

Buy insurance up to age 60

Many agent advice consumers that they need to buy life insurance for the whole of life. This is bad advice.

The consumer only need to buy life insurance up to the time that their youngest child reaches age 25. By that time, all the children would have been financially independent. This is likely to be age 60 or 65 (for those who have their children at an older age).

There is no need for life insurance after age 65. If the consumer had been prudent in having regular saving during their working life, they are likely to have sufficient savings to take care of their retirement needs. This could amount $250,000 for an ordinary wage earner or more for a high income earner. With this savings, there is no need for life insurance cover.

The agent likes to advice consumers to buy the most expensive insurance policy, as their commission is directly linked to the amount of premium. They can earn between 12 to 24 months of the savings. If you save $300 a month, you may lose $7,200 of your savings to pay commission to the agent or the expenses and profit of the insurance company. This is a lot of money to give away, especially as the saving plan does not give you an attractive return (compared to saving in an low cost unit trust) and imposes a heavy penalty if the policy is terminated prematurely.

You should have your savings separately and buy Term Insurance or Family Income Benefit for 25 years or up to age 60 years (if this is shorter). This is adequate for most people. But you can consider your own financial situation to make a suitable decision. Do not be misled by an insurance agent or financial planner who is only interested in earning a higher commission.

Tan Kin lian

Life insurance for family protection

You only need to worry about life insurance when you have dependents, e.g. after you are married and have children. In the event of premature death, the life insurance policy will take care of the financial needs of your dependents.

You should buy a low cost life insurance, such as a Term Insurance or Family Income Benefit. If you take the insurance at a young age, you only need to insure for 25 years, as your children would have been financially independent on the expiry of the insurance. Furthermore, after 25 years, you would have accumulated sufficient savings, and life insurance is not needed at that time.

If you buy Term Insurance or Family Income Benefit at an older age, you can buy for a shorter period, e.g. until your youngest child reach age 25. If you take up the insurance when your youngest child is 10 years old, you only need insurance for 15 years.

The best insurance is actually a Family Income Benefit. You can insure for 60% of your current earnings. If your monthly income is $5,000, you can buy this insurance to pay $3,000 a month in the event of premature death (i.e. during the term), for a benefit that is payable for the remainder of the term. If you buy a 25 year insurance and death occurs after 10 years, the Family Income Benefit is payable for 15 years.

Alternatively, you can buy a Term Insurance to provide a lump sum of 5 years to 10 of your annual income, for a term of 25 years. If the term is less than 25 years, you can reduce the insurance sum proportionately. If you need insurance for the next 15 years, you can insure for 3 to 6 years of your income.

A Family Income Benefit is better than Term Insurance, as your family will not have to worry about investing the lump sum payable on premature death. Instead, they will receive a monthly income.

You can upgrade your Term Insurance or Family Income Benefit every 3 to 5 years, to increase the insurance in line with your higher earnings. However, even if you do not, the basic benefit should already cover most of your financial needs of your family.

You can visit this website to get an indication of the premium rate that you should be paying for Term Insurance. Although the website is for America, you can get an idea about the premium that you should be paying for similar insurance in Singapore. I have not been able to find a website to give the premium rate for Family Income Benefit.
 
Tan Kin Lian

Buying Term Insurance from America

Someone asked me about the risk of buying Term Insurance from America. They premium rate is much lower than the rates available in Singapore and it is easy to buy through the internet. Here is an example of a website.

I am not aware about any risk. I believe that it should be quite easy to make a claim, if the need arises. You should choose a financially strong and reputable company. I have asked two lawyers to give me their views. I will past the replies when I received them.

Of course, it is better to buy Term Insurance from an insurance company in  Singapore, provided that the premium rate is competitive and they make it easy to buy directly through the internet. It is all right for you to pay up a higher premium for the convenience and assurance, but the difference should not exceed 20% compared to the best rates available in America. I hope that competition in Singapore should force the premium rate down to the same level as in America (as the life expectancy and health status in Singapore is better than in America.

Tan Kin Lian

Unfair reduction in bonus

A policyholder found that the bonus on his maturing policy had been cut by 40% compared to the original projection issued on the point of sale. The reason given by the insurance company was that the bonus was cut due to several economic crisis during the past years. The policyholder argued that one company - who had gone through the same crises- did not cut the bonus, but his the insurer rejected his argument.

The policyholder asked my views on the fairness of the bonus cut and if there is any point in lodging a complaint with FIDREC.

I encourage him to lodge this complaint with FIDREC. A large part of the bonus cut is probably due to the cut in terminal bonus. This cut might have been necessary earlier during this year, when the stock market dropped sharply. However, the stock market had recovered by 60% (from its lowest point) during the past six months. It is only fair that the cut should be partially restored. I hope that FIDREC will consider this point in its adjudication.

Tan Kin Lian

Medishield - MOH misinterpreted my suggestion

This letter was printed in the Strait Times a week ago. In its reply, the Ministry of Health mis-interpreted my suggestion. I have written a further letter to the Straits Times to clarify this matter.

I had asked the Ministry to contact me on my suggestion. They did not. This has caused them to mis-interpret my suggestion. It is quite sad that our civil servants and leaders continue to decide on important matters without seeking clarification or engaging the public.

Using subsidised wards (B2)

There are two big advantages of using subsidised wards (B2)

a) You get a subsidy of 50% to 65% of the hospital bill
b) As the government is paying a large part of the bill, they will check that the bill is reasonable.

If the patient has to pay 100% of the bill (i.e no subsidy), there is a risk that the hospital may charge more, or give more treatment than necessary. You have to pay 100% of a larger bill.

I estimate that a bill from a private hospital could be 3 times of the subsidised bill, for the same treatment.

Some people said that the doctors treating patients in subsidised wards are under training and not experienced. I do not agree with this comment. It may be true that the doctors are under training, but they do the routine medical checks and are supervised by the experienced doctors.

When it comes to surgery or other major procedures, an experienced specialist will carry out the procedure. There is really no need for the patient to choose his own doctor.

However, if the patient is willing to pay a higher bill to be treated in a private hospitals or A class ward, and enjoy the privilege to choose their own doctor, it is all right. They can also buy insurance for the more expensive treatment, but the cost of the insurance can be three times.

Tan Kin Lian

Make traditional policies good for consumers

I wish to address the questions: What is wrong with traditional policies, such as whole life, endowment or critical illness, which have been sold for decades? Can the shortcomings be corrected?

The shortcomings are:
a) High upfront charges - as much as 160% of the annual premium
b) Lack of transparency
c) Fair distribution of bonus

These shortcomings can be overcome by:
a) Reduce upfront charges
b) Adopt the asset share method - improve transparency and ensure fair distribution of bonus.

Using the asset share approach, the insurance company has to give an annual statement to the policyholder showing the premiums paid, the charges taken out of the premium (for mortality risk and expenses) and the interest credited (based on the investment yield earned by the fund) and the asset share. The asset share has to be paid to the policyholder on the termination of the policy.

This transparency will help to reduce the upfront charge (as consumers will never agree to have 160% of their annual premium taken away). The transparency and competition will make the upfront charge to disappear one day (similar to opening a savings account in a bank!)

Some countries (e.g. Malaysia) have already adopted the asset share method and also placed a modest cap on the upfront charge. If a similar approach is adopted in Singapore, I will be happy to recommend the whole life, endowment and critical illness plans as being good for consumers.

tan Kin Lian

Arbitrary decisions on health insurance claims

This article contains several letters on arbitrary and illogical decisions taken by health insurance companies on insurance claims. They argue for regulation.