Learn About Life Insurance

4 Apr 2014
Mr. Tan Kin Lian started work in 1966 and qualified as a Fellow of the Institute of Actuaries in 1975. 
He joined NTUC Income, Singapore in 1977 as the general manager / chief executive officer. During this stewardship, the assets of the cooperative increased from $28million to $17 billion and became a leading life and general insurance co-operative.
Mr. Tan is now the President of the Financial Services Consumer Association (FISCA), a non-profit organization formed to educate the public on financial planning. He has published a few books on life insurance and financial planning. He also lectures as an adjunct professor in a university in Singapore.
The contents of these articles are personal opinion of Mr. Tan Kin Lian and have not been edited by easicircle. Reader's discretion is advised.
No part of this book shall be reproduced, stored in a retrieval system, or transmitted by any means, electronic, mechanical, photocopying, recording, or otherwise, without written permission of the author.
Copyright: Tan Kin Lian & Associate Pte. Ltd
ISBN:
June 2013


Introduction
Many people find a life insurance policy to be confusing.
They find it difficult to decide between the different types of policies that are available and to choose which different insurance company to buy the insurance from.
They usually depend on the recommendation of an insurance agent (or financial adviser) who approaches them.
The insurance agent is likely to recommend a life insurance policy that pays an adequate commission to the agent. After all, the agent has to make a living.
I have written this book as a guide to the consumer to know what to look for in a life insurance policy and to judge if the policy gives good value to the consumer.
It will help the consumer to evaluate the recommendation given by the agent. It will also help consumers to find where they can buy the right type of insurance and investments on their own.
I have adapted this book to be used by the easicircle platform. I commend this platform for its effort to make affordable insurance available to consumers.
Tan Kin Lian
Different Types of Policies
There are basically three main types of life insurance policies, namely
  • Term insurance, which pays out the sum assured in the event of premature death during the term of the policy.
  • Endowment insurance, which pays out the sum assured on premature death during the term and also on survival at the maturity date (i.e. at the end of the term).
  • Whole life insurance, which pays the sum assured on death and the policy continues during the lifetime of the policyholder.
Most consumers like the endowment policy, because they can get their money back at the maturity date. The whole life policy is quite attractive to the consumers.
In the next chapter, I will explain how the consumer should evaluate between these three types of policies.
Duration of premium
Most life insurance policies require the premium to be paid for the duration of the policy, e.g. 20 years of premium payable for a 20 year policy. This is described as "regular premium".
Some policies require a premium to be paid over a shorter period, for example, premium payable for 10 years only under a 20 year policy or a whole life policy. This is described as "limited premium".
Some policies require a premium to be paid once only, at the start of the policy. This is described as "single premium".
If the premium is payable for a shorter period, you need to pay a larger premium to obtain the same sum assured.
The premium can be paid yearly or in installments every one, three or six months.
Unit linked policies
There is another category of life insurance policies called "unit linked policies". They have become quite popular in many markets. I will also explain about this type of policies in a later chapter.
How to evaluate a policy

Let me illustrate with this example.
A consumer wishes to save $5,000 a year over 20 years. If he is able to invest this savings on his own, e.g. in good quality shares in the stock market, and earns an average return of 5% per annum; the savings will accumulate to $173,000. The total savings is $100,000 and the remaining $73,000 comes from the investment return.
If the consumer puts the same savings in a 20 year endowment policy, he will probably receive less than $173,000 at the maturity date, assuming that the insurance company is able to invest the savings at the same rate of return.
The lower payout from the endowment policy is due to:
  • A part of the premium has to be used to provide the insurance protection, i.e. to pay out the sum assured on the premature death of some policyholders.
  • The commission and other marketing expenses.
  • The administrative expenses and profit margin of the insurance company.
Assume the reduction to be 25% in the above case, i.e. $43,000, giving a maturity benefit of $130,000. The consumer may think that this is still a good investment, as he gets more than the premium of $100,000 paid over 20 years and enjoys the protection, i.e. "peace of mind", of a big payout to the family in the event of premature death.
This is not the right way to evaluate the endowment policy. The correct way is for the consumer to find out if the "peace of mind" can be obtained at a lower cost, compared to $43,000.
This is where the term insurance policy maybe more suitable for the consumer.
If the consumer buys a term insurance policy to provide the same protection over 20 years, the cost of the term insurance is policy likely to be only 5% of the savings and not 25% shown in the above example.
The consumer can then invest the remaining 95% of the savings to get a projected sum of $164,000 (i.e. 95% of 173,000) which is much higher than the maturity benefit of $130,000 payable under the endowment policy.
I have used a reduction of 25% as being realistic for an endowment policy of 20 years. This reduction is likely to be higher for a longer term policy or for a whole life policy.
In the above example, I have calculated the figures based on assumptions, but I have tried to use figures that are quite realistic in reflecting what is happening in the life insurance market in many countries.
You can use this method to evaluate an endowment or whole life policy that has been recommended to you.
In the case of a whole life policy, you can assume that the policy is terminated at age 65, and use the surrender value at that time as the maturity benefit.
If you find that the endowment or whole life policy is not attractive, as the reduction is too high, you will need to find another solution.
This is called the "buy term and invest the difference" approach, or the "do it yourself" or D-I-Y approach.
I will explain it in the next chapter.
Do It Yourself

When you decide to "do it yourself" instead of relying on an endowment or whole life policy, you have to:
  • Buy term insurance to provide the "peace of mind" that is needed for your family.
  • Invest the rest of your savings in good quality shares and bonds to earn an attractive return, which is as good as what the life insurance company can earn on your savings.
Term insurance
In the past, it is difficult for consumers to buy term insurance, as it is difficult to find an insurance agent to sell this type of policy to you; the agent does not earn sufficient commission for the time spent.
You will have to buy it directly from an insurance company through their Internet platform.
There will soon be an easier way for you to buy term insurance, using the easicircle platform. I will explain it in a later chapter.
Index fund
You can invest your savings in an index fund that is invested in the leading shares that are quoted in your local stock market.
In the next chapter, I will explain the concept using the index fund that is available in Singapore, called the Straits Times Index Exchange Traded Fund (STI ETF). You should be able to find a similar fund in your country, if you are not living in Singapore.
I will also explain the concept of minimizing the risk of investing in shares. When you understand this concept, you will feel secure about making investing in the index fund.
Insurance protection
I will also explain some of the common types of insurance protection available to consumers. They are low cost insurances that do not have any investment embedded in the policy.
Advantages of D-I-Y
There are two important advantages of the D-I-Y approach compared to investing in an endowment or whole life policy.
Flexibility
The D-I-Y approach gives you the flexibility to increase or reduce your regular savings according to your personal circumstances.
You can even make withdrawals from the index fund at any time, e.g. to meet cash emergencies, without having to suffer a penalty.
The endowment and whole life policy do not provide this kind of flexibility.
Better return
The D-I-Y approach is likely to give you a better return. The cost of protection is likely to be only 5% of your savings, which is lower than the reduction in the maturity benefit that is embedded in an endowment or whole life policy.
Tax relief on premiums

There is an advantage of the endowment or whole policy that may mitigate its disadvantage.
When you invest your savings in a life insurance policy, you are allowed to claim relief from your income tax subject to certain limits.
If you are paying income tax at the rate of 10% and the entire savings (i.e. premium) is eligible for relief, you enjoy a saving of 10%.
If only half of your savings is eligible for relief, your tax saving is 5%.
This tax relief is not available to you when you invest your savings in the index fund.
You should take the tax relief into account when comparing between investing in a life insurance policy (through an endowment or whole life policy) and investing on your own (i.e.D-I-Y).
Straits Times Index ETF
I wish to explain the key features of the index fund, called the Straits Times Index Exchange Traded Fund(STI EFT) that is available in Singapore. You should be able to find a similar index fund in your country.
You can use the index fund as a benchmark to evaluate other types of investment choices available to you.
The STI ETF is invested in the 30 leading companies that form the stock market index in Singapore. They are mostly the blue chip companies, i.e. large, well-managed companies with a long track record of profitable business results.
The components shares are in various industries, e.g. banking, manufacturing, transport, telecommunications, shipyards, media and property. They are well known companies.
These blue chip shares earned an average yield of 9.2% over a period of 20 years up to 2006. I do not have the figures up to 2012, but it is likely to be more than 8% per annum.
You can reduce the risk of investing in shares through diversification and investing over the long term.
Diversification
The STI ETF provides diversification over 30 shares. It saves you the headache of evaluating the different shares and reduces your risk of choosing the wrong shares.
Some of the component shares may perform badly in some years (and some may even become bankrupt). As only a small proportion of the fund is invested in each share, the impact of any bad performance is small and will probably be compensated by the good performance of other shares.
Market cycles
There will be certain years where the entire stock market will perform badly, and most of the shares in the index fund will fall in value. Your investment in the index fund may suffer a big loss in these years.
You do not need to worry. The stock market can go up and down in cycles. Over the long term, the returns in the good and bad years will average out and give you an attractive average return. The average return for the STI ETF was 9.2% over 20 years.
Low expenses
A key advantage of the index fund is the low expense ratio. This is the amount that is taken away from your investment yield to pay the fees of the fund manager and the other expenses of managing the investments of the fund.
Most index funds have a low expense ratio compared to actively managed unit trusts.
The STI ETF has an expense ratio of 0.3%. If the average return from the underlying shares of the fund is 6%, the net yield to be investor is 5.7%.
Most actively managed unit trusts have an expense ratio of 1.5% to 3%.
The difference of 2% in the expense ratio can make big difference over a period of 20 years or longer.
Dividend
The STI ETF provides pays a dividend twice a year. The annual dividend is about 2% to 2.5%.
The remainder of the yield comes from the long term appreciation of the underlying shares.
Insurance protection
Term insurance
If you are married and have children, you will need insurance protection to provide a large payout to your family in the event of premature death.
The best way to provide this protection is by buying a term insurance policy for 25 years or shorter, i.e.until your youngest child reaches age 22.
You can buy insurance for 5 to 10 years of your income.
The cost of this insurance should be within 1% of your income. If you earn $60,000 a year, you can set aside $600 a year for this insurance.
Within this 1% budget, you can set aside a small amount to buy critical illness cover (which pays a lump sum in the event of a critical illness), but you do not really need to worry about it, if it is too troublesome to get the cover.
Most critical illness will occur at an older age. By that time, you would have accumulated sufficient savings to pay for any loss of income due to critical illness. The cost of treatment is likely to be covered by a medical insurance plan.
Personal accident insurance
You may consider buying a personal accident insurance, if you find it difficult to get term insurance due to your health condition or other reasons.
If you encounter this difficulty, just ask for a personal accident insurance, which is easily available from many insurance companies.
The cost of a personal accident insurance is less than half of a term insurance, but it covers death or injury arising from accidents only, and not for natural causes.
The risks faced by most young people are from accidents and not for natural causes anyway.
Medical insurance
You do not need to worry about medical insurance for the following reason:
  • If you are working, your medical bills are likely to be covered by your employer.
  • The risk of contracting a serious illness is quite low for young people.
  • You may contract a serious illness at an older age, but you would have accumulated sufficient savings at that time.
If you are not covered, you can buy some low cost medical insurance.
Unit Linked Policies
In recent years, unit linked policies have been introduced in several countries and have become quite popular.
These policies are similar to endowment and whole life policies in several aspects.
The consumer pays a single or regular premium into this policy. A part of the premium is taken away for the distribution cost, cost of insurance and cost of administration.
The remainder of the premium is invested in units of one or selected investment funds.
Compare to D-I-Y
The unit linked policy is similar to D-I-Y approach in several aspects.
The key difference is the charges. The unit linked policy tends to have much higher charges, compared to D-I-Y. However, this may be offset by tax relief.
The investment risks are similar.
By now, you should be able to make the comparison and evaluate which is a better option for your future.
Financial advice
If you find it difficult to evaluate the various options available for your financial planning, you should consider getting the services of a financial adviser or planner and be willing to pay a fee for the advice.
Some adviser may be willing to give advice for $250 or at $50 to $100 per hour. You should be prepared to pay this fee, as the financial adviser needs to make a living.
The advice may be worth a lot more to you, as you can earn much more on your savings, if you invest them in the right way.
However , if you are knowledgeable and make the evaluation on your own, there is no need to pay this fee.
easicircle Platform
Insurance
easicircle is an Internet Platform that has been designed to make it easy for consumers to buy insurance protection conveniently and at a low cost.
It will approach a few insurance companies to offer their term insurance, accident insurance, medical insurance and other attractive insurance packages.
Consumer education
In the future, the platform will also be educating consumers about the benefit of the D-I-Y method of financial planning.
This book, which is written by Mr. Tan Kin Lian, is an example of our educational effort.
Index fund
The platform may look for partners to offer their index funds or ETF to our members at a later date.
Register now
To qualify for the attractive benefits offered by this easicircle platform, you should register now. It is easy and FREE.
Do tell your friends and relatives to sign up as well, so that they can enjoy the same benefits.
Conclusion
Many consumers put a large part of their personal savings in a life insurance policy without understanding if this is the right choice for their financial planning.
I have written this book to educate consumers on making the right choice and to show the advantage of the "Do It Yourself" approach, i.e. to buy term insurance and invest the rest of the savings in a low cost index fund.
I urge consumers to read this book and be ready to pay a fee for independent financial advice, as it could make a big difference to their future financial outcome.
Please help me to spread this message to your friends and relatives, so that they can also make the right choice.
Tan Kin Lian

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