The truth about life insurance

Tan Kin Lian

Many people buy life insurance to provide financial security to their family. If premature death occurs, the policy provides a cash sum to take care of the future financial needs of the family.

Insurance agents are drilled into thinking that they play a “noble” role in safeguarding the future of many families. This is half the truth.

Here is the other half: Many families are being grossly overcharged for the modest financial protection offered by the life insurance policy. After deducting the high expenses, their net savings do not earn a sufficient yield for them to live on during their retirement.

Let me quote a real example. Take the case of a male at age 30 saving $300 a month over 30 years. He is able to secure a sum assured of $100,000 under an endowment policy.

If premature death does not occur (and this represents probability of 95%), he is likely to receive a maturity sum of say $171,000, representing a yield of 3% per annum on his savings over 30 years. The insurance agent says that this looks like a good deal, considering that his family had enjoyed financial security for 30 years.

If the policyholder had invested the same sum of money in a low-cost investment fund that mirrors the investments of the life insurance company, he is likely to earn a net yield of about 5% per annum. At the end of 30 years, this will give an accumulated amount of $239,000.

This investment fund earns $68,000, or 40% more than the proceeds of the insurance policy. This is reflected as the “effect of deduction” in the benefit illustration given to the consumer at the point of sale of the life insurance policy. Most people are not aware about the existence of this figure, let alone understand what it means.

The effect of deduction of $68,000 represents a “reduction in yield” of 2% per annum, i.e. the difference between the net yield of 3% and the gross yield of 5%.

The insurance agent will probably explain that this is the cost of the valuable benefit provided by the policy, namely, the financial security provided to the family for 30 years.

What the agent did not say, which is probably dishonest, is that the policyholder could have bought the same financial security to the family through a decreasing term insurance policy for only one-tenth of the cost, or about $7,000. The low cost term insurance, which is what the agent does not offer to the policyholder, will allow the policyholder to earn $61,000 more over the 30 years.

The remainder of the “effect of deduction” goes to pay for the agent’s commission, the overriding commission to the agency managers, the advertising expenses, the sales incentive trips, the overhead expenses of the insurance company, and the profits for their shareholders.

If the policyholder buys a whole-life policy or a critical illness policy, the “effect of deduction” is higher than that for an endowment policy. Although the coverage is higher and wider, the total cost is still about ten times of the cost of a comparable term insurance plan.

The investment-linked policy is equally bad for the policyholder. I have seen benefit illustrations for these policies where the reduction in yield is 4% or more. If a reduction in yield of 2% amounts to $68,000, a reduction in yield of 4% will more than double the cost. This is taking too much from the unsuspecting consumer. It amounts to daylight robbery.

Here is my advice:

1. Do not buy any high-cost life insurance policy. High-cost life insurance plans are those where the policy combines life insurance protection with savings. Low-cost life insurance policies – term insurance policies – cover protection only.

Examples of high-cost life insurance policies include whole life, endowment, critical illness, education and investment-linked policies, where many months of your premium are used to pay the insurance agent’s commission.

2. If a policy is recommended to you, you should ask about the “effect of deduction” and the “reduction in yield”. If the insurance agent is not able to show these figures, you should stop the discussion as the agent is incompetent or dishonest. Ask the agent to disclose the total amount of commission payable over the first three years of the policy. Remember, the commission comes entirely from your premiums.

3. Find out about the cost of decreasing term insurance to provide the same coverage. Do not ask the same agent, as he or she is likely to quote you a large premium. Call the hotline of another insurance company. If they do not provide a decreasing term policy, you can buy a level term policy for a higher premium.

4. The coverage of $100,000 is probably inadequate for your family. You need to be covered for about five years of your earnings. Most people need $200,000 or $300,000. If you buy decreasing term insurance, you can afford to have higher coverage as the cost is low.

My history in NTUC Income

Some people will point out that during my tenure as chief executive of NTUC Income, I had offered the same life insurance policies that are now being discouraged in this article.

Here is the truth. The policies that were sold during my time have a cost to the policyholder that is less than half of similar products in the market. This is achieved by reducing the agent’s commission and the administrative, marketing and other expenses. These policies give a return on maturity which is 15% to 30% higher than similar products in the market.

This statement applies to the old policies introduced during my tenure. I do not wish to comment on the new policies introduced by NTUC Income after I have left. The consumer should ask about the “effect of deduction” and the “reduction in yield” on these new policies and make their judgement.