Perhaps the most overlooked component in most people’s portfolios is insurance. It is common for the young to think about investing from a very young age but they fail to realise that just like investing, they must manage their risks in life. A savvy investor will look into purchasing adequate insurance for himself and the ones around him. He will want to avoid a situation whereby an unforeseen illness or accident will require him to cash out of his investments or have him dip into monies what were set aside for investing. Even though insurance coverage should be one of the first things everyone should purchase, the reality is that most young individuals do not think of purchasing insurance when they receive their first paycheck. Instead they think about how to make their first forays into the stock or property market.
Purchasing an insurance plan shields you from unexpected financial shock. Imagine committing to a 30 year mortgage without purchasing an insurance plan. You would have to be extremely sure that you will stay healthy for the tenure of the mortgage. If an illness were to strike and you were left with little or no coverage, you might have to sell your property to pay for medical bills. If the property market was weak at that time then the property may be sold at a financial loss. Investing in the stock market is no different. Stocks are extremely liquid investments and thus they go through wilder swings of volatility as compared to property. Imagine having to cash out of your investments because of a medical emergency. You may be forced to sell at a time when the market is in a correction or you may have to cash out of your dividend yielding stocks even though they are giving you good income.
There are many forms of insurance to cover just about every facet of one’s life. However for the sake of discussion I will be talking about life and medical insurance.
Life Insurance
Life insurance covers a person in the event of death, disability or when critical illness is contracted. When either situation occurs, the insurance policy will pay out the benefit as stated in the policy. There are two types of policies. Participating and term policies. The third policy is somewhat a hybrid of the two.
Participating Policies are policies which will accumulate in value as time progresses. In essence premiums are paid to the insurance company and the insurance company uses a certain amount to purchase insurance coverage for you and invests the rest. The insured does not have control as to what the insurance company invests in but he does receive bonuses which will accumulate in his policy. He will receive a statement most probably annually and if the insurance company’s investments do well, he will receive more bonuses and vice versa. These policies are useful for people who want an all in one solution to insurance and investment with as little management as possible. As premiums are paid over the years, the value of the policy will increase. If the insured is unable to pay his premiums for whatever reason, maybe he is out of job for a few months, he can apply for a premium holiday and the value within the policy will pay for the premiums. When the insured has reached a certain age, say 75 years old, his children may already be financially stable. He may choose to cash out of his policy and use the monies for his retirement. He may have purchased such a policy so that in the event of his demise or illness, his family is taken care of. Since he has an adequate medical plan, he may choose to surrender his policy and use the monies to enjoy his retirement. To many, participating life policies are their only retirement planning.
The advantage of a Participating Policy is that it is hassle free and simple to understand. Most people should purchase a participating policy.
Term Policies are similar to participating policies just that they do not have the investment portion attached to them. A term policy provides coverage and that is about it. Due to their lightweight nature, they are usually much cheaper than participating policies. Term policies are for people who want full control over where and how their money is invested. Many stockbrokers subscribe to the mantra “Buy term and invest the rest”.
The advantage of a Term Policy is that it is cheap and simple to understand.
Investment Linked Policies or ILPs for short are a more flexible hybrid of the two. There is a managed investment portion whereby certain portion of the premiums paid are used to purchase certain funds or unit trusts and the insured can alter the level of coverage to suit his needs. The cost of coverage goes up as a person ages. This cost of coverage is called the mortality charge. When young and without a family, a larger portion of the premium should be used to purchase units in the chosen funds. When a family comes along, the insured can lower the amount of premium used for investment and increase the amount spent on purchasing insurance coverage. During old age, the mortality charge may be extremely high and if needed the insured can use all or almost all of the premium to purchase coverage and invest very little to nothing. However, if his children are no longer dependent on him then he can choose to continue to use his premiums to purchase investments or simply cash out of the policy. ILPs are extremely flexible insurance policies but the insured needs to be well aware of the rising mortality charges. The only way to mitigate the high mortality charges in the later years of his life would be to start the policy from a young age and try to make sound fund choices in the investment portion of the policy. If you do not have a very active financial adviser or you are not into reading fund fact sheets then this type of policy is not for you.
The advantage of an Investment Linked Policy is that it is an all in one product.
So how much insurance should a person purchase? My personal take would be to cover at least five years worth of income. So if a person was earning $50,000 per annum, he would purchase a policy which would have a death benefit of $250,000. Of course if this person had a large number of dependents then he should perhaps purchase a little more. My calculation here takes into account the death benefit only. There are many other riders which can be added to a policy to protect the insured from many other unfortunate situations like total permanent disability and critical illnesses.
My personal advise for those who are just starting out would be to purchase a life policy when you start working. Purchase slightly more than sufficient coverage to take into account your possible future pay increases. If you are an engineer with a starting pay of $50,000 per annum perhaps you would want to purchase 5 times of $80,000 instead which is coverage of $400,000. If in future your annual income rises to more than $80,000, let’s say $120,000 per annum, then you may want to purchase a term policy for that extra $40,000. The reason why you should do this is that in the unfortunate event that you lose your current high paying job, you can get a replacement job of $80,000 as that is the market rate for your level of experience and expertise. Since you are over insured by $40,000, you can reduce your coverage by terminating your term policy.
Medical Insurance is equally important. Unforeseen accidents may occur, illnesses may strike at the most unexpected moments. It is important to purchase a Medishield Plan. Such a plan covers the insured by paying a certain portion of the medical bills. Furthermore, such plans can be paid using monies in your medisave. All Medishield Plans have deductables and coinsurance. Let’s say your Medishield Plan’s deductible is $2,000. This means that for the first $2,000 worth of treatment, you will have to bear the full cost. After that you will share the cost with your insurer by paying the coinsurance portion. Coinsurance means that the insurer will pay a certain percentage and you will pay the rest. For example the insurer pays 80% and thus you will have to pay the remaining 20%. To not have to pay for the deductible amount and your share of the coinsurance, you will need to purchase an add on plan on top of the basic Medishield Plan. Such an add on plan can only be purchased using cash.
Life and Medical Insurance are extremely important before one embarks on investing in equities or property. I cannot stress the importance of getting the right coverage to avoid the risk of your jeopardising your investment portfolio.
Yours Sincerely,
Daryl Lum
p.s. I am currently not a financial advisor. I was previously a financial advisor for a period of time. However I hold a Certified Financial Planner (CFP) certification from the Financial Planning Association of Singapore. I am currently dealing with general insurance and I hold a license to deal with general insurance with the General Insurance Association Of Singapore (GIA). I also hold a real estate salespersons license with the Council for Estate Agencies (CEA). I run a private equity fund and blog about investing.
p.p.s. For financial advice, you may contact Leon Tan from AXA Life at +65 9850 0376 or Jeffrey Lim from Great Eastern at +65 9455 1621. I am not receiving remuneration in any way or form for recommending them.
