Thursday, 10 September 2015

Has an entire generation been ill-advised on Financial Planning? (Part 1)

Whole life insurance is a financial product which many of us own or are recommended by banks and financial planners. Recently, I came across a 15 year premium whole life product with a sum assured of $100,000. Its annual premium is in the region of $2,155. It got me thinking: Are there ways to obtain better returns, at lower risk but with the same amount of sum assured?

For whole life insurance, it is a combination of term insurance and an investment component. And while the benefit illustrations of this product states the projected returns are 4.75%, the actual return calculated from the table will be slightly lower, around 4.2% to 4.5%.

Creating the Common Man’s DIY Insurance

Jerome (age 27) decides to create his own product which replicates a similar 15 year premium whole life. To replicate the components of whole life, he does the following:

Term Insurance

Jerome buys the AVIVA NS Term which covers him for a sum assured of $100,000. The plan costs $153.60 per year (for public servants, you can use the POGIS which costs $60 per year for every $100,000 of sum assured).

Investment component

As mentioned, most insurance consist of an investment component where majority of funds are allocated for investments in different asset classes- bonds, stocks etc. This is to generate the projected returns.

Jerome mirrors this and creates a portfolio with two asset classes, bond and equities. He will put $800 in the STI ETF and $1200 into “CPF bonds”, to form 40% equity and 60% bond portfolio. To buy these “CPF bonds” for his bond component, Jerome does an annual voluntary contribution to his CPF SA. As the “CPF Bond” is backed by the Singapore government, his bond component is triple A rated of very low risk. The returns of these "CPF bonds" are guaranteed ( 4%/ 5% for the first $60,000 combined).

With only 40% of portfolio subjected to market risk, Jerome’s portfolio is far less risky than any insurance’s. You can read here about voluntary contribution to the CPF SA.

Total Premiums paid

The annual premium Jerome pays for his own DIY is $2,153.60

Premiums paid

It is worth noting, Jerome still has to pay premiums of his Aviva NS term insurance from the age of 42 to 65 unlike for a 15 year premium whole life. In my analysis, Jerome’s premiums are covered during this period for the following 2 reasons. Firstly, the NS Aviva term provides returns during good years (about 1-2 month premium is returned). Hence during good year, Jerome receives 1-2 month rebates which he invests into the SPDR STI ETF. Since inception in April 2002, this ETF has generated an annualised return of approximately 7.11% as of end August 2015. This includes the market rout witnessed during the past two months.

Secondly, as Jerome had been topping up $1,200 yearly into his CPF SA, he received a tax savings of $84 annually. Similarly, he invests the tax saving proceeds into a STI ETF (annualised 7.11% returns) and then start depleting it from age 42 to 65, hence covering his premiums. In fact, Jerome still has $2,352 leftover from this method after paying the premiums until 65.

So it seems our very own DIY product is viable and less risky. In my next post, I will explain how this plan generates a higher projected return. 

Click here to continue.

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