Thursday, February 26, 2009

My ideas on insurance

As a lay person to insurance, it is not easy to ‘break into’ the knowledge banks of insurance. While I profess that I’m no way near a level where I can tell people what to do with their insurance, at least for now, I understand my own insurance needs and plans – which is the raison d’etre for wanting to know more about insurance.

Let’s just talk about the difference between a whole life plan and a term plan. A whole life plan is an insurance policy where the insured gets a cash value, usually towards the 3rd year of the policy. This cash value will grow in value, and it consists of two parts – the non-guaranteed part (usually projected at 3.75% or 5.75% pa) and another guaranteed part. The whole life insurance plan puts the premium that you pay into a participating fund (par fund for short). This par fund consists of a mix of assets, usually more geared towards bonds (higher percentage) and equities (lower percentage). Back in the heydays of bull markets, insurance policies of olden days project their non-guaranteed returns at a rate of 7-10% (that’s what I heard from others) and the selling point of these policies is the high cash values (as always, compared to fixed or savings accounts in banks) that the insured stands to gain when he cashes it out. I think it didn’t work out too nicely when the insured realized that the actual cash value is so far off the projected returns years down the road.

Well, on paper, anything goes. The best and most sophisticated model might not yield the most accurate predictions. Hence, for me, I never like to look at the non-guaranteed part of the cash value. It’s better to plan your life on not having the non-guaranteed portion than to have a shock in the future. This philosophy of not looking at the non-guaranteed portion of any cash values in policies extends not only to whole life but to other savings plans too. I just never look at the non-guaranteed part of the cash values. Call me a conservative if you wish.

To me, insurance is not about investment. I do not think highly of mixing insurance with investment. Obviously not everyone thinks the same as me, hence it’s crucial to decide how you treat insurance. As KK puts it, are you treating insurance as an expense or as an investment? If you treat it as an expense like me, you’ll want a cheap insurance with maximum coverage in terms of both breadth (i.e. how much coverage) and length (i.e. duration of coverage). You’ll not care for any cash benefits or returns because this is immaterial to your purpose of buying insurance. On the other hand, if you treat insurance as an investment, then you’ll want to worry about how much returns you are getting, and whether the returns are mostly in guaranteed part or non-guaranteed part, the composition of the par fund etc.

There are no bad insurance products, just a mismatch between products and the buyer. If you want to be serious in being financially independent, you’ll have to take responsibility in finding out more about insurance as it’s an integral part of being financially responsible to yourself and your family.

Now, what about term plans? Term plans, firstly, have no cash values to talk about. It’s purely for insurance and the premiums you paid are not put into the par fund to grow it. Hence, the premiums are usually much cheaper (around 4 times cheaper, all else being equal).

I think it’ll be good to list the comparison between term plan and whole life plans here:

Personally, I’m holding 2 whole life policies. One is a traditional whole life policy where the policy will be in-force as long as the premiums are paid. The other is a limited payment whole life plan where the premiums are paid for a period of your choice of 10 yrs, 15 yrs, 20 yrs, 25 yrs etc, but the policy will be in force till you expire (or up to age 100).

The reasons I bought and the reasons I’m holding are quite different. Since the reasons why I bought are less than stellar, let’s talk more about why I’m still holding on to the whole life plans:

1. For the limited payment whole life plan, I like the fact that after a period of 15 years (I chose it), I do not have to pay for the premiums anymore. This will cover me for 100k for the rest of my life, with an additional option to change to an annuity upon hitting a certain age. This means that I will not have to pay for the premiums for this plan when I reached age 45, well before my retirement age. This certainty is well worth the extra premiums I paid for this plan.

2. The limited payment whole life plan will be my base insurance coverage till I expire. I have no intention to convert to an annuity plan nor to cash it out, otherwise I would not have any more coverage. Should I hit any unfortunate event after I cashed out my plan or converted to annuity, my savings will be eroded. This is not something I would want to happen towards the end of my life.

3. The other traditional whole life plan I will have to cut upon hitting retirement. I wonder how I can pay the premiums to keep the policy in force after I stopped working. Hence towards the end of last year, I started to cut the initial 180k coverage to 50k to reduce the premiums paid. Thus, I would have a sum of money ready the moment I decided to cash out this policy.

Having settled my base insurance, I will next work on temporary coverage using term plans. This will start as soon as I start my family. The reasons why I chose term plans are:

1. The term plans is to boost my insurance coverage in case something happens to me, so my dependents will need a sum of money to maintain their current lifestyle. But as my dependents get less dependent on me, I do not need to have such coverage anymore.

2. Ideally, I plan to boost my insurance coverage using term plan, for a period of D+25 years, where D is the year where my last child is born. 25 years should be sufficient time for the last child to earn his/her own keep and hence will no longer be dependent on me. The term plan should also be sufficiently cheaper than whole life plans, so the financial burden will not be too great on me.

The whole idea here is to use a combination of whole life and term plans to achieve exactly the goals you want to achieve for insurance. Limited whole life plan to act as a base insurance coverage, topped with term plans to boost coverage until the dependents get less dependent. Of course, other essentials like hospitalization and surgery (H&S) plans, personal accident (PA) plans and disability income plans are crucial for a well rounded insurance coverage. Perhaps more on those in future posts.

Note that I'm not a qualified financial advisor. I'm just posting my thoughts on it, and I do not advise anyone to follow my own philosophy towards insurance. Do seek the proper advice if you need more help. There is a possibility that the information given here is wrong. Hey, what do you expect from a layperson trying to break into the insurance bank? Gimme a break (literally)


Createwealth8888 said...

The main objective of life insurance is to cover part of lost income when something happens to us so wee should project the insurance coverage till the day when we will stop working and paying of premium should stop at the same time. E.g. one will retire at 65 or 67, then life insurance should also stop at 65 or 67.

The other is a limited payment whole life plan where the premiums are paid for a period of your choice of 10 yrs, 15 yrs, 20 yrs, 25 yrs etc, but the policy will be in force till you expire (or up to age 100).

This one is not recommended as it is not wise to be covered by life insurance when one has no income unless one want to give away money to their children ha ha.

Anonymous said...

Hi Createwealth8888,

In the event that you retire, the limited whole life plan should have been fully paid up. You will still be covered without having to pay a cent ya?

For insurance till age 65 or 67, it really depends on how you look at it. Ideally, by then your investments will have done well, you have a sizable retirement fund and you have your children to support you but in the worse case scenario, where your investments don't do well, your retirement fund is dwindling and your children are not able to support you, what will happen to you when you fall sick? Also, it is statistically proven that major illness mostly happen after age 65, and that's when most term plans end.


Admin said...

Hi Derek,

The way I look at it, life insurance is more to provide an income for dependants in the event of death and TPD. So the question to ask will be "How much will my dependants need when I am no longer able to provide for them?" From what I know, the last age of entry for term insurance is normally around 50-65 but coverage can be renewed up to 70-75. By then, hopefully your children are independent and your spouse has an adequate retirement fund. Coverage up to age 100 under life plan is more for bequest purposes.

The question "what will happen to you when you fall sick?" should be addressed by H&S and/or critical illness. Life insurance won't pay when you fall sick.

dream said...

bro, excellent post! :)

la papillion said...

Hi bro8888,

I understand your pt of view. There are many schools of thoughts regarding this.

In my view, the main concern about insurance is not only to provide income for dependents. It's equally important not to burden your family in the event that you are struck with illness without any coverage.

I ask myself this question, what happens when I'm 68 yrs old (say) and I got critical illness? Will I be able to pay off the medical bills without any insurance coverage? Will I have to dip into my savings to pay it off? What if my savings are used up and I'm cured? What kind of life will I be subjecting myself to?

That scares me enough to think about having coverage even after dependents are no longer dependent on me. I think it's only fair that I do not become a liability to my children when I'm old.

la papillion said...

Hi Derek,

Hey, I have the same philosophy with regards to insurance as you. My parents do not have any insurance coverage (save for h&s plans which I had bought for them not too long ago). I shudder at what happens should any thing happen to them? Will their savings be enough to foot their medical bills? Will I have to foot on behalf of them?

These questions make me rethink about how I should cover myself in old age too, so as not to be in the same situation as them. I certainly do not want to be a liability to my children.

la papillion said...

Hi Dancerene,

Unless you have a stand alone critical illness (CI) plan, it might not be enough to cover H&S for critical illness. Reasons? H&S covers you as long as you are in hospital. What if you are out of hospital but have to hire someone to take care of you? These will not be covered by H&S plans, hence a separate CI plan is crucial to give a lump sum to settle such things.

I'm not sure whether the stand alone CI plans are term. If that's the case, it'll come back to the same prob with term plans - that the coverage will lapse at a certain age. Whole life/limited whole life have the adv of having a CI plan riding onto it (they usually comes along with it for most plans), so the CI coverage will last as long as the whole life plan lasts - That's the whole point of getting a whole life coverage for me.

la papillion said...

Hi dream,

Just sharing my view points on insurance. Been thinking about these for some time already.

Anonymous said...

This is my first visit to your blog, nice writings. Just want to make one comment to your D+25 protection policy. You might want to consider getting hose reducing term policy as the obligation towards your child decreases as they age towards 25. Reducing term is cheaper than a plain 25 years term.

la papillion said...

Hi anonymous,

Thks for your good suggestions. Yes, that is a very good option. I've thought about it actually. The article I wrote is about the big picture i.e. using whole or term to cover what sort of needs. As for the details (like the amt of coverage and the type of products), will have to work out with a financial advisor who will know more than me :)

Thks for visiting :P

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