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?
12 comments:
Apparently you did not grasp your actuarial science concepts well.
Your comparison is an unfair comparison, as you did not take into account of time factor.
You should compare term plan plus invest the difference with whole-life plan.
If I use 5% discount rate (the rate at which insurance agents love to use), I obtain a residual wealth of $212,000, sufficient for an average premium of $10,0000 from 79 yrs old till 99 yrs old (assuming that the $212,000 is not further invested).
IMO, the true cost of a term plan is basically the cost of its premiums, period.
However, the true cost of a term plan in relative to a whole life plan is subjected to a number of factors; one of which is the rate of return that is earned by deploying the opportunity cost (assuming that the person is an advocate of "Buy Term, invest rest).
2 Points that you may highlight.
1) The Sum at Risk decreaes over the years in a Life policy, especially into the older ages. A term policy do not and Sum at Risk stays level.
2) The effect of deduction is not taken into consideration for this analysis. EOD is based on 5.25% for most insurers. Not considering if the person invested at a rate of 6%p.a
Its not too much a matter of WL better or Term better. Its unfortunate that most advisers tell their clients to buy a Wholelife to meet their needs than using a Term. When a large premium is used for a WL plan, the likelihood is that the person will not be able invest effectively for better returns.
You should take into consideration of discount rate and the opportunity to invest the initial 30 years excess cash flow savings for purchasing the term. Don't mind for saying this but your comparison does look a bias without taking into consideration of these two factors.
Not forgetting life policies acquires cash value too !
Melvin
It's not about the total cost outlay for 99yrs.
Can you tell me what is the purpose of buying a term plan or a whole life?
May i suggest that it is to offer adequate coverage for the person that will be equal to at least a minimum sum that will be enough to tide his family over any financial difficulties after his departure.
If so, then whole life and term plan is just part of the component for financial planning. That is only for financial coverage to replace lost income from the deceased. The other component is the savings one (that you can do with your commission-laden ILP or to adopt the buy-term-invest-the-rest philosophy). When you looked at the total package, there will be more pros than cons for doing a term-invest-rest than whole-life and buy ILPs/endowments.
Hi,
Thank you for your feedback. As you've mentioned aptly, 'what is the purpose of buying a term plan or a whole life' and I agree that both term and whole life has their own place in financial planning. The problem arises when individual rely exclusively on one or the other, and then want to change their stance in the future. Also, one point to note is that insurance is not just for a person's departure - it can also be an instrument to relieve massive medical costs.
Hi Thinknotleft,
Thank you for your feedback. Can you share with me how you derived the residual wealth of $212,000?
You are right that term plan should be bundled with investment. However, it is possible that rather than buy-term-invest-the-rest it becomes buy-term-spend-the-rest? As far as I understand there is a thin line between profit and loss in investment. :)
Hi Collin Yeo,
Thank you for your feedback. Indeed the efficient deployment of the opportunity cost resulting in reasonable returns is one of the greatest factor that makes term plan a better option than whole life.
Hi Melvin,
Thank you for your feedback. Indeed, the whole life policies do acquire cash value but only from 2-3rd policy years onwards. If you wish to cash out, please ensure that you do so after the break-even year, if not you will be getting less than what you put in. :)
Hi Finarati
Presumably you may already have the answer to your question.
Your follow-up post is a halfway there. Extend your analysis there from year 31 to 52 (or age 57 - 78), and using your provided term cost of $3481, you will get the $212,000.
Wrt your second para: Yes, it may turn out buy term and spend the rest. It's up to the person to decide whether he has the discipline to buy term and invest the rest. If not, he may be paying expensive fees to instill the nec discipline.
Hi ThinkNotLeft,
Thank you for following my posts. Can you kindly clarify your statement so that I can offer you an appropriate reply. I do not understand what analysis of mine you are talking about.
By the way, thank you for your agreement on the need for discipline. If by paying some fees one can ensure that he/she will have some savings eventually, its better than by saving the fees and end up having no savings at all. :)
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