Sunday 30 August 2015

For Young Singaporeans, For Financial Freedom: Basic things to know about Insurance

Besides seeking to insure yourself before investing, young individuals (just starting out in their careers) may seek financial advisers to set up a retirement program. However, we will often be presented a few products which may seem complex and daunting due to the thick pages and jargon. Hence to help readers understand some of these common products, this article will seek to do a basic explanation and define how they work. As this article uses examples of death, I will like to warn of the post’s bluntness which may offend readers.

The Different Products

Term, whole and endowment are the most common products recommended by financial advisers for our retirement planning. So let me illustrate them with a simple matrix.

Provides funds to dependents fordeath during coverage
Term of Coverage
Does it have an Investment component?
When are the investments paid?
Typically 5 to 40 years
Not applicable
Entire Life
When you die
Mature after a fixed period
At expiration of  policy

For term insurance, it is a plain insurance which covers you for the term of period opted. For example, if you purchase a term insurance to protect you until the age of 65, should you die on the day after your 65th Birthday, you do not receive any pay-outs. However dying anytime from now till the age of 65, your dependents will get a “death pay-out”. In addition, it does not have an investment component.

In endowments, it is a combination of term insurance and an investment component. There is a maturity for endowment plans where you will receive a lump sum pay-out. For example, if I were to buy an endowment plan which matures in 20 years’ time; should I die within these 20 years, my dependents will receive a “death pay-out” and “cash bonus”. However should I live beyond the maturity; and because the investment component of my endowment will have accumulated a sum of money, I will only receive the amount of “cash bonus” at the end of maturity, and not the “death pay-out” amount.

Whole life is similar to endowment. The only difference is whole life does not have a maturity period and covers for your entire life. Hence once you die (you can’t live forever), your dependents will receive a “death pay-out” and “cash bonus”.

Lastly, I will like to highlight for both endowment and whole life, we may opt to surrender the policy anytime and receive a sum of cash bonus. However, this will result in us obtaining only a small sum, which is undesirable.

How does the investment component work?

Projected returns vs Actual returns

In our policy document, there is a benefit illustration table which informs us how much we will receive upon death. The death benefit is the sum of “death pay-out” plus “cash bonus”. In the benefit illustration page found in very policy, there is a guaranteed amount which is the death pay-out while the non-guaranteed portion is the “cash bonus” accumulated. You may wish to review these benefit illustration page in your policy.

In the benefit illustration table, the non-guaranteed amounts are projected to have returns of either 3.25% or 4.75%. Do note the 4.75% projection is not the actual annualised returns you will obtain. For whole life, the returns under a 4.75% projection will in fact yield you about 4.2% to 4.5%. This is because some of your premiums are used to pay for the product’s distribution cost etc.

In addition, Investment moats did a review of endowment plans in Singapore and found the actual annualised returns for endowments range from 2.7% to 4%, with one giving an exceptional 5.25% and another a negative 11.65% return. So one can safely assume endowment annualised returns are 2.7% to 4% which is below that of whole life. Investment moat's article can be found here.

Achieving the returns

So how are our premiums invested? The insurance company will have a fund who will seek to achieve the projected investment return stipulated in your policy while controlling the risks. The fund will do so through active management of a mix of asset classes. Below is a mocked up example of a fund’s asset allocation table.

These funds are in the wealth management industry and often have links to the insurance company. 

Which is the best?

The choice among these 3 financial products is hugely dependent on the financial circumstances of individual. And because this is unique across individuals, I am unable to give a broad stroke comment on what to choose. I can only say, due to my own financial circumstances, term insurance is my best option.

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