I am a strong advocate of insurance. I see it as mandatory. There is always a need to mitigate risk and insurance companies fill that need. Whether you are driving a car, running a business or simply taking a trip overseas, unexpected events may happen. Insurance companies are there to take on this risk. They do this by pooling together a group of people who want to mitigate this risk. Actuaries, professionals who assess the financial risk of particular situations, will then come up with the risk premium attached to this pool and the insurance company will charge everyone a premium. In the unfortunate event that something may happen, be it a car accident or a plane delay, the insurance company will compensate the insured. This is the basis of insurance. To cover against unforeseen events, essentially mitigating risk.
Then comes life insurance. There are generally two forms of life insurance products. Participating and non-participating. Participating policies are entitled to the bonuses of the investment returns of the insurance company. Non-participating policies are not entitled to such bonuses. Due to this difference, participating policies such as traditional whole life policies are more expensive than non-participating policies like a term life policy. The charges that you actually pay for coverage is called the mortality charge. The excess amount which you pay above this mortality charge in a participating traditional whole life policy is used by the insurance company to invest in certain asset classes. This is why there is a benefit illustration table in your policy document which shows the guaranteed and non-guaranteed bonuses. There is a surrender value to the policy and you can take a loan or a premium holiday on your participating traditional whole life policy. A traditional whole life policy is focused mainly on protection and less on savings. A larger amount of the premium is used to pay for mortality charges and a smaller amount is used to invest.
This then poses a conundrum for some. There is a group of people who want a larger portion of the premium paid to be invested instead of paying mortality charges. This would bring the coverage down significantly but then the policy would accumulate value much faster. Savings plans cater to these people. They focus on accumulating value rather than on protection. There is still protection embedded in the policy but not much. The plans are for a certain number of years, typically around 20 years. Many buy such plans for their children when they are born and aim to have the plans mature when they reach adulthood. Some may buy when they are in their 20s and plan to have the plan mature when they reach their 40s. There are even people in their 40s that buy the plans for their retirement in their 60s.
Here is why I think savings plans are the worst thing you can buy from insurance companies.
1) Insurance and Investments should be kept separate
There is a saying “buy term and invest the rest”. This is what a typical investor would do. Personally, I would only buy non-participating term policies as they provide the highest amount of coverage at a much lower cost. I can understand the relevance of having a participating whole life policy with a small proportion of premiums going towards investments. However, I can never understand the rationale of placing monies with an insurance company for the purpose of investment. The savings plans’ distribution cost is extremely high. Moreover, part of the premium is then syphoned away to provide for protection, digressing from the original intent of the policy in the first place. These two reasons are strong enough in itself to know that this is not going to be a sound investment.
2) The policy timeframe is advantageous to the insurance company
Imagine this, you buy a policy when you are in your 30s. It has a maturity date when you are in your 50s. Typically you should be healthier when you are in your 30s than in your 50s. Yet the insurance company can collect premiums from you while you are younger and can get out of insuring you when you are older. This arrangement is extremely advantageous for insurance companies. Place yourself in the shoes of the insurance company. Would you rather have a portfolio of young insured or old insured? Typically the younger the client base, the lower the claims experience.
3) Saving plans are like low-cost loans to insurance companies
The saving plan’s structure consists of a small proportion of protection and a large proportion of funds going to investments. You cannot choose where to invest the funds. The insurance company will decide for you. To do this they need to have a team of people. Typically fund managers. These people need to be paid and there are costs involved in maintaining and running these investments. Administratively the cost is relatively huge. This is before the typical bonuses paid to the people managing these investment funds. All things taken into consideration, the rate of return paid out to policyholders is not extremely enticing. If the insurance company were to go to a bank to borrow these funds to make these investments, they would be charged a much higher rate of interest and they would be at the scrutiny of the bank with regards to how they use the money.
4) Information on investing is readily available
In the past one could argue that there was nowhere to learn how to invest in stocks, bonds and other financial instruments. However, in today’s day and age, information is readily available online. If you were looking for information on how to trade stocks, many brokers have free courses that can shed light on this matter. A simple Google search will yield results and there are many people blogging and creating videos about investing in various asset classes. Taking time to learn how to trade is not very difficult in today’s digital age.
5) There are safe financial instruments that can get you decent returns
Government bonds or bonds issued by government statutory boards pay decent returns. Government bonds are in the region of 2% per annum and statutory boards like the Land Transport Authority (LTA) issues bonds that pay about 3-4% per annum. On top of this, investors can also buy into companies that pay healthy dividends. Placing monies into stocks of traditionally healthy dividend-paying sectors like telecommunication companies are often seen as a safe bet.
6) Insurance companies have at times failed to deliver on even the lowest end of their predictions
There are many cases whereby clients have felt disgruntled over the poor returns that they received from their insurance policies. Some insurance companies have provided reasons like the ’97 Asian Financial Crisis, The Dot Com Bubble and the 2008 Financial Crisis as a basis for missing the projected returns. Timeframes in the region of 20 years is a long enough time to expect a major economic shock to occur. Thus there is a chance that the projected returns will not happen. In a savings plan, your money is locked for the duration. In the event of a shock to the financial system you cannot withdraw your monies and ride out the wave. If you were to invest your monies yourself, you would have more control over the ability to take money off risky assets in the event of any financial crisis.
I personally feel that savings plans are not relevant in today’s digital age. Investing is already made so much more accessible and information about almost all asset classes are available on the internet. We should be purchasing insurance policies from insurance companies. That is their core business.