Deconstructing the Investment Linked Policy

I've been helping a client check out an investment linked policy, and here are two interesting points to help people make sense of investment linked policies:

1) What is an Investment-Linked Policy (ILP)?

Basically an ILP is a policy that combines term insurance with investment. Essentially ILPs consist of 2 parts:

A) a term insurance portion which gives you the insurance coverage and
B) the investment portion which would give you the investment returns.

There are two important features of ILPs:

A) For the term insurance portion you usually get a smaller sum assured than a 'pure' term insurance. For instance, one particular ILP derived its sum assured based on 4-5 times of the annualized premium. So if you are paying an annual premium of $1,200, then the sum assured will only be $1,200 X 5 = $6,000. Now compare this to a 'pure' term insurance. The same amount of $1,200 per year can get you a 30 year term insurance of (now go ahead, make a guess):

1)$100,000
2)$200,000
3)$300,000
4)$400,000


Have you made your decision? Good, now scroll down. :)


Yes $400,000! I hope you got the right answer. :) So the question is: why pay the same amount to get a fraction - literally 1.5% - of the coverage?

B) Unlike other types of insurance like whole life and endowment, ILPs have two distinct characteristics:

i) High rates of projected returns.

ILPs have higher rate of projected returns that range from 5% - 9%, while the whole life and endowment usually projects between a range of 3.25% - 5.25%.

ii) Do not have any guaranteed return.

ILPs DO NOT have a guaranteed return. Usually the returns for the whole life and endowment policies are broken down into the guaranteed and non-guaranteed portions (for illustrations do refer to my previous post on the term plans). This means that the ILPs do not have any guaranteed returns.

So what are the implications?

The implication for this is that you may get the professed returns on one hand, but on the other hand you might not get anything back (not even the initial amount you put in).

2) How to make sense of the benefit illustration (B.I.)? What do all the columns of confusing figures mean?

You can refer to this useful guide which explains the various columns in details.

The True Cost of Whole Life Plans

In my previous post I've written about the true cost of terms plans, which evoked a discussion and gleamed some important points. This particular post is to address 'the other side' of the spectrum - the whole life plans - and hopefully balance the bias.

Using the previous case study of the 26 year old male, I shall expound on it and determine what is the true cost of the whole life plan to him. Now, in terms of the cost, there are actually two types:

1) The 'actual' cost of the policy (i.e. how much he has to PAY for it).
2) The 'opportunity' cost of the policy (i.e. the value of the next best alternative forgone as the result of making a decision. In this case it is usually assumed to be better investment returns).

Now, if the insured were to purchase a limited-payment whole life policy rather than a term plan, his 'actual' cost would be $2,394.15, which is the annual premium.

On the other hand, if the insured were to purchase a term policy, his 'actual' cost would be $312.70, which is the annual premium.

So essentially there is a yearly difference of: $2,394.15 - $312.70 = $2081.45

In other words, the insured would have an excess of $2081.45 per year if he had opted for the term instead of the whole life.

Once we ascertain the excess, this is where the second aspect of cost comes in - the opportunity cost. Here it simply means what better use could he have for the $2081.45 - like for instance investing. If the insured uses this amount of money to invest for 30 years (put in $2081.45 for a limited-payment of 20 years and let the the amount accumulate till 30th year) at a range of hypothetical rates of returns, he will get back the corresponding amounts:

Annual rate of returns - Amount at the end of 30 years:

0.00% - $41,629
3.25% - $78,997
4.00% - $91,748
5.00% - $112,109
5.25% - $117,888
6.00% - $137,120
7.00% - $167,857
8.00% - $205,640

So that's quite a lot of returns from 'buy-term-invest-the-rest' huh? Whole Life can't match this. No way. Right, so let's see where the whole life stands.

Surrender Value of Whole Life - Amount at the end of 30 years:

0.00% - $55,300 (i.e. just the guaranteed amount)
3.25% - $76,540 (i.e. guaranteed of $55,300 + non-guaranteed of $21,240)
5.25% - $91,987 (i.e. guaranteed of $55,300 + non-guaranteed of $36,687)

If he were to surrender the limited-premium whole life at the 30th year, he will get back $76,540 (assuming an investment returns of 3.25%). So the 'buy-term-invest-the-rest' wins by a margin of...$2,457. After all the consistent work. For 30 years. The efforts are worth $2,457. No wonder they say that making money is tough. Phew.

Hey but if he were to have an annual returns of 5.25%, then the 'buy-term-invest-the-rest' will exceed the whole life by $25,901! Not too bad huh? So the only way to make his efforts worth it is to ensure that his investment returns is greater than 3.25%. Maybe 5.25%. Or even 8%. The best is 20% like Buffett. But whether Mr Insured can attain that - well that's a different story. If Mr Insured isn't that great at investing, and he gets 0% returns...well he might be better off with a whole life because he'll get $13,671 more.

So the true cost of whole life is not just the premium he have to pay, but also the possible opportunity cost of losing out on investments (we are talking about positive returns here ok...no he wouldn't lose his capital). Alright. Now go. Take the money and invest. He just have to make sure that he earns enough returns for his needs and efforts (easy, surely he can do much better than 5.25%). Oh by the way, he's got to ensure that he have at least $100,000 after 30 years - which is the sum assured he forgo to do the investment.

The True Cost of Term Plans

In the course of my work, I've met clients who claimed that term plans are better than whole life plans because they are 'cheaper'. Indeed, on the surface the premium of a term plan is much lower than that of a whole life plan. However, when I did a comparison of a term plan versus a limited premium whole life plan, I discovered that there is a catch to it: the term plan is only cheaper for a LIMITED period of cover, and not for LONG TERM coverage (as shown in Table A).



To do a proper comparison, I have set certain constant variables:

1) Profile of Insured: Male, Non-Smoker, 26 years old.
2) Sum Assured: $100,000
3) For the term plan (inclusive of Critical Illnesses cover) the intended coverage is for 30 years.
(I derived this from an actual case study, whereby this particular client only insured for 30 years because he perceived insurance to be necessary to cover his productive years, and that he has no use for it in his golden years.)
4) For the limited-payment whole life plan (inclusive of Critical Illnesses cover) the coverage will continue on till 99 years old (assuming there is no lapse in the policy).
5) That the annual premiums quoted are based on the present, level rate (discounting the possibility that the premiums might increase over the long-run).
6) There is no issue of buying the plans due to health problems.

So in all, the total premiums paid for the term plan over the 30 years of protection will be:
$312.70 X 30 years = $9,381.00

Now compare this to the total premiums paid for the limited-payment whole life over the 20 years:
$2,394.25 X 20 years = $47,883

That appears to be a lot right? But consider this fact - the term plan only covers for 30 years, while the whole life plan covers till 99 years old, which equals to 73 years of coverage.

Now, to obtain a "fairer" comparison, we should look at the cost per year of protection:

For the the term plan the cost per year will be:
$9,381.00 / 30 years = $312.70

For the limited-payment whole life plan the cost per year will be:
$47,883 / 73 years = $655.93.

So now although the difference is narrowed, no doubt the term plan is still HALF the cost of the limited premium whole life. But that's where the advantage ends. If you decide to change your mind and want to extend your term plan, the problems sets in.

1) For the term plan, the most you can extent is till 79 years old. Comparing it to the limited-payment whole life, there is a "self-insure" gap of 20 years.

2) The premiums for the term plan increase sharply from $312.70 to $3,481.00. Thus the total premiums he had to pay will be:

$3,481.00 X 22 years (from 57 yrs to 79 yrs) = $76,582.00

Thus the average premium he pays for the term plan over 52 years will be:

($9,381.00 + $76,582.00) / 52 years = $1653.13.

Now compare this with the $655.93 of the limited premium whole life. What is the true cost?

Medical Benefits: Employer Bears the Burden

This is an update on the previous post "Medical Benefits: Who bears the burden?" The Senior Vice-President of Toast Box replied to Mr Lim and assured that the company will compensate his son for the 'work-related injury' ("Part-timers entitled to medical benefits", 04/06/09, Pg. A27). I do applaud Toast Box's responsible reply by offering to "compensate part-time employees if they suffer personal injury from an accident that arises out of, and in the course of, their work", and hope that this will set the standard for equitable treatment towards all employees.

However, that being said, one must be aware of the countless incidents that went unreported and therefore ignored. Thus it is important for people - especially the contract workers - to know what are their basic benefits as well as the appropriate alternatives to seek reasonable redress. Please do not go overboard, lest one gets naught ("Injured worker fails in bid for higher payout", 04/06/09, Pg. B5).

Medical Benefits: Who bears the burden?

I came across this sobering story ("Part-timers run equal risk but no medical benefits", 30/05/2009, Pg. A41) in the Straits Times Forum which set me thinking. This letter was written by a parent in response to his/her son's predicament when he was injured at work. Essentially, being a "part-time" worker, the son had to face a double jeopardy because:

1) He had to pay for ALL the expenses incurred (such as the taxi-fare to the hospital, the medical fees and the follow-up treatment) as the employer did not provide any medical benefits for 'part-timers'.

2) Although he was granted 10 days MC, that translates to a loss of 10 days worth of income as he is paid according to the hours he worked.

The central question that this incident raises is who should be the one that bears the burden of providing medical benefits? Is it the individual employee, or the employer? In fact, my opinion is that the party who faces the risk of greater loss should be the one who bears the burden. Put simply - you might risk losing your life and limb, while your employer risk losing...an employee? Out of a whole lot. And most probably someone not even remotely related to the boss. Get the picture?

Thus it is pointless to point the finger at employer due to the position involved. Part-timers or temporary worker simply do not have the bargaining power (unless ALL of them can band together and demand for more equitable benefits) simply because they are perceived to be easily replaceable, like cogs in the machine. However, even if the employer DOES provide medical benefits, these benefits might cease when one is no longer working there.

Thus, it is important for people 'privatize' their medical insurance, and to ensure that they have a personal medical coverage which is independent of the employers. This is so that you will not be at the mercy of others when the need arises. Some employers do provide a comprehensive cover, but that should be taken-with-thanks rather than taken-for-granted. If you can claim from your company good for you, but when you have no one to depend upon at least you can fall back on yourself - and not flat on the ground.