When can Whole Life Insurance be better than Term Insurance?

The topic of buying Life Insurance popped into my mind again recently when the Straits Times covered a topic of how Insurance Product options have expanded online and how it can be purchased without the need of going through agents. So perhaps it is a good time to re-evaluate when Term Insurance is better; and when Life Insurance is better.

Previously, I did a short write up of the common types of Insurance shown which can be read here. Hence if you need a basic understanding of how Term and Life insurance works, you may read it before continuing this post.

The "Money Psychology" associated with Term and Whole Life Insurance

My conversations with others on the topic of Term and Life Insurance has unveiled an interesting observation. Many individuals do not consider the value of their Whole Life Insurance policy when calculating their net worth or for retirement. This is intuitive because you yourself will never get to see the sum of money since... oh well you know. Hence many people view life insurance as an expense, whose premiums unfortunately form a significant portion of their take home salary.

Conversely for Term Insurance, as the premiums paid is so much lower than that of a Whole Life, one is able to save more. Currently, the premiums for a term insurance is approximately s$150 per year for a $100,000 coverage, while the premium for whole life insurance is about s$2,200 yearly. This means a savings of about s$2,050 yearly. 

This is one of the reasons why you see a few bloggers possessing a 6 figure investment portfolio despite being in their late 20s or early 30s. It is simply due to the fact that they (we) use term insurance to insure ourselves instead of Whole Life (and also our high propensity to save ratio). As a result of this, society seems to think we are in a better position to retire early and better.

Let's show it mathematically through two individuals who plan to insure themselves for a $200,000 coverage - Mr T (who will utilize Term insurance) and Mr WL (who will use Whole Life). In a short span of 10 years, assuming a return of 4% earned on the difference, Mr. T will be ahead of Mr. WL by $49,225.
                              

Savings over 10 years at 4% Average Returns

To summarize, individuals do not view Whole Life Policies as part of their retirement fund despite the premiums paid being much higher than that of Term. On the other hand, those who purchased Term insurance are able to see the tangible difference by a faster rate of accumulation in their bank balance; and if they were to invest wisely this difference, they will have a higher net worth compared to individuals on Whole Life. This sums up the "money psychology".   

When can Whole Life Insurance be better than Term Insurance?

So the question beckons? When can Whole Life be better?

The answer boils down to the individual - i) when the individual is ill-disciplined in savings or ii) the individual is not very good in managing his money/savings.

Following from my above example, an individual will have an extra $4,100 yearly. He can either a) Save this amount or b) Spend it away. An individual who is indiscipline at saving or poor in managing his money will do exactly b); spending it away for present consumption and not saving for retirement.

Seen in this light, one will notice that Whole Life Insurance is in fact a form of "Forced Saving" scheme. This is because it takes a significant amount of your take home pay now, locks it away until the end of your life to help you benefit from the magic of compounding. Unfortunately, the downside is that you will not enjoy the maturity sum, only your beneficiary.

The Returns from Being Locked Away

So what do I mean by saying an individual is not good in managing his savings? Well it means not knowing how to put the money saved from term insurance into good use (returns). While Whole Life publishes that their projected returns are 4.75% etc, readers will know that the true returns for many such policies are approximately 4% per annum.

If an individual has the discipline and is able to make use of schemes such as POSB-invest saver or ETF to invest in a basket of  shares belonging to companies of credible financial strength, achieving a long term average of 4% is achievable and feasible.

Similarly, if an individual is terrible in investing such that he is always making negative returns annually, then Whole Life might be a better option of locking away his savings for accumulation. However, an altering of his psychology has to be done to come to the realization that the maturity sum from his whole life is part of his retirement plan. Alternatively, he can try to surrender his policy near his 70s to use the proceeds to fund his retirement. 

However surrendering a life policy is not the best option because it reduces the returns to the region of 2-3% per annum; which is pretty achievable if you had started by putting money in your CPF special account at the beginning (CPF SA provides 4% annual returns). 

Summary

If you lack the financial discipline to save or is an individual who is unable to control one's own expenditure, Whole Life may perhaps be a better option scenario. This is because it acts as a form of "Forced Savings" that locks away part of your income for the future. Similarly, if your savings is generating less than 2% interest per year, utilizing a Whole Life policy to help in retirement planning may be an option as well.

It is at this juncture, that I would suggest to tap on another form of forced savings - topping up into your CPF Special Account. This is because it earns a close to risk free 4% returns with the benefits of a one-time tax deductions. However, there is a cap to how much you can top up into your CPF-SA.

Related Link: http://investmoolah.blogspot.sg/2015/09/this-is-better-than-singapore-savings.html

Spend Less on Bubble Tea if you want to be rich and healthier

Most people would have heard about the money hack on cutting back on Starbuck's latte to increase your savings.

Some will have recently heard about Australian's Millionaire Tim Gurner rant on Advocado Toast and how it is making millennials poorer.

Locally too, we have a beverage (food) that is making Singaporeans poorer.

The Bubble Tea

Initially, I wanted to paste a picture of LiHo's or Gong Cha's Bubble Tea; however to avoid potential lawsuit for damaging their business, i guess better not! So down to the facts.

The Bubble Tea is a favorite Singaporean beverage and costs about $3- $3.50 per cup, especially among the younger generations. If an individual decides to reduce the occasions he drink on a weekly basis say from 5 times to only once. The annual savings will be: $3X 52X4 = S$624. That translates to about 20% of a young office worker's monthly take home pay.

And that's not all !

The Potential Health Downside to drinking too much Sugar Drinks (e.g. Bubble Tea)

Initially, I wanted to paste a picture of PM Lee's National Rally and the 'war on diabetes"; however to avoid any potential flaming by netizens of political affiliations etc, i guess better not! So down to the facts.

Recently, PM Lee delivered a somber fact that diabetes is becoming increasingly prevalent among Singaporeans. Let's face it, getting diabetes drains you financially because you will have to pay for the medical treatments, consultations etc. 

And general knowledge tells you one of the main reasons why you get diabetes is because you have consumed too much sugar in your lifestyle. That's where the nasty bubble tea fits in - it has many cubes of sugar (even if we order at 50% sugar).

Hence while cutting down on drinking bubble tea provides you the instant savings of $624 annually, it also reduces your risk to diabetes, preventing from having to bear the financial strains of incurring medical expenses for diabetes.

Summary

To summarize and to build on and quite fellow blogger, Kyith's words: Diabetes can be traced to as a function of affluence and if you look at the insatiability of Singaporeans to go for gong cha, koi, llao llao. The hunger for such snacks borders on addiction and is becoming a problem.

Cutting down on such sugary treats will not only reduce our risk of health problems in the future. It will also save us money in the present. No doubt we Singaporeans are becoming more affluent; however our hunt for food filled with sophisticated and deep flavors should not come at too high a price, damaging our health and financial freedom goals. 

A review of Starhub's Dividend Sustainability

From my previous post on Starhub on Feb 2016, I asked about the sustainability of the company's 20 cents dividend policy on a cash flow basis. You can read the previous article here. 

Since then Starhub has reduced its dividend policy to 16 cents annually. This means Starhub has to generate $277 Mil of cash to deliver its 16 cents dividends.

What has happened?

Since then, Starhub has experienced 2 events. 

Firstly, the issuance of a s$200 mil perpetual securities with a 3.95% yield. In my opinion, the proceeds from this perpetual securities is likely to be used for to repay Starhub's maturing debts such as its Sept 2022 bonds. Hence, it is likely this perpetual securities is used as an instrument to roll over Starhub's debts to a longer duration. 

Secondly, Starhub has experienced a deterioration in its business environment and erosion of its moat. In its recent Q2 results, Starhub experienced a net profit drop of 20%. Its pay TV and mobile segments saw a fall in revenue and user subscription. Fortunately, Starhub's cash generation ability did not deteriorate by 20% in tandem. From the results, Starhub's operating cash flow before working capital changes for the first half of the year was s$339 million; and if we are to extrapolate it on an annual basis, the company is generating about s$678 million per year. 

Starhub's cash flow Statement as of Q2FY2017

Are the New Dividends Sustainable?

So to recap, Starhub now needs a free cash flow of s$277 mil to support its dividends. With an extrapolated cash flow generation ability of s$678 mil, we will have to deduct the following few cash outflow items first:

i) Maintenance Capex - s$300 mil (based on past annual reports)
ii) Income Tax of about s$60 mil
iii) Finance Expense of s$30 mil (based on Q2 results)
iv) Annual distribution to perpetual holders of s$7.9 mil

In addition, I have estimated that Starhub will be receiving about s$10 million in government grants. This is about a 66% fall from previous FY but a rather fair estimate as seen in its cash flow statements

Starhub Q2 cash flow Statement (Financing Activities)

This leaves Starhub with s$290 million to distribute as dividend or about 95% of its estimated cash flow generation ability or nearly 100% (if we exclude government grants)

To conclude, it seems Starhub has just about sufficient cash flow to support its current dividends. However, with such a huge amount of debt in its balance sheet and the increasing competition experienced in the mobile segment, it may be prudent for Starhub's management to re look at its dividend policy. Perhaps one good way is to announce that the company will distribute 90% of its free cash flow instead of guiding for a fixed amount of dividends it will give on a yearly basis.