Saturday, November 20, 2010

Garrett Goh's original letter

Garrett Goh has sent me his original letter (see below) that was sent to the Straits Times. The Straits Times editor published an edited version.

TO: Straits Times (for publication on ST Forums)

I refer to the ongoing discussion on insurance products (Lim Pueh Joo, "Investment-linked policy works best for me", Straits Times, Nov 19), specifically to address the “advantages” of investment-linked policies (ILP).

Mdm Lim is technically correct in that once the term insurance period ends, renewal premiums will be costly if a person develops a medical condition. However, she has failed to understand that purchasers of term insurance are not looking to renew their policy at the end of their term. Buying term insurance is only half of the strategy. One should not forget about the other part, where advocates of term insurance will save and invest the difference between the premiums of a comparable ILP policy and term policy. As written in my earlier letter, for an insurance coverage of $500,000 for a mid-20s male, this sum is about $8000/yr. Assuming that this difference of $8000/yr is invested in low-cost investment instruments and grows at a moderate 5% per annum for the next 40 years (till retirement age), the accumulated "cash value" will be $1,000,000. Consumers who buy term insurance and invest the difference will very likely be able to accumulate their own "cash value" by the time the term policy expires, and this self-accumulated "cash value" will be at least equivalent if not greater than the insurance coverage purchased. Having a personal "cash value" is also more advantageous, because one can claim one's own money without restrictions like adhering to the strict definitions of 30 critical illness.

I am pleased that Mdm Lim has found her ILP returns to be good. However, I would advise her to make an appropriate comparison before jumping to conclusions. It is well known that ILP introduce many additional fees that increase their effective expense ratio. Low cost investment products have an expense ratio of about 0.50%, which is much lower than the ILP expense ratio that may be around 2.0% or higher. The high ILP expense ratio will be detrimental to her financial health in the long term. Using the above hypothetical scenario (which assumes a gross 5% returns per annum), if a consumer were to save and invest the $8000/yr difference for the next 40 years, the ILP investor would accumulate a cash value of about $600,000 versus the DIY investor's cash value of about $850,000. Personally, I find the idea of giving the insurance company a quarter million dollars a total rip off. ILPs only appear to be a win-win situation because consumers are not well educated about the cheaper alternatives out there.

Garrett Goh

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