There is a popular saying that life insurance is sold, rather than bought. Nobody wakes up one day telling themselves, “Maybe today is the day that I should buy some life insurance”. This rarely happens.
Insurance is important. But what is equally important is understanding what it is that you are buying.
Two Types Of Life Insurance Policies
When you buy life insurance, there are typically two types of insurance policies that you can choose from.
The first type is called term insurance. It works in a simple way: you choose the duration of coverage and how much you want to be insured for, and the insurer quotes you the premium that it will charge.
If an insured event occurs during the policy duration, you (or your dependants) get the insurance payout. If you are fortunate enough that nothing happens during the policy duration, the policy lapses and you receive no payout.
The second type is a called a whole life participating policy. Such policy usually matures at age 99 (hence the term, whole life), and comes with a cash value component within the policy. There are also whole life insurances that are non-participating.
According to MoneySENSE‘s definition, participating policies are insurance policies that provide both guaranteed and non-guaranteed benefits. Policyholders are allowed to participate or share in the profits of the insurance company’s participating fund. This is paid in the form of bonuses or cash dividends. Bonuses and cash dividends are non-guaranteed benefits.
In this article, we will look at an important component of whole life participating policy that may be overlooked by consumers.
Read Also: Understanding How Whole Life Insurance Works
Does A Whole Life Participating Policy Allows Me To Make Investment Returns On My Life Insurance Policy?
Because there is a non-guaranteed cash value component attached to them, some consumers presume that a whole life participating policy is a substitute for an investment plan. It’s not.
A life insurance plan is exactly what its name suggests, a life insurance plan. It’s not (and has never been) a substitute for an investment plan. As we wrote in a previous article, policyholders should not make the fundamental error of thinking that a life insurance policy is an investment plan just because it projects an investment returns in its benefit illustration.
A Quick Look At The Returns For Participating Funds In Singapore
Earlier this month, Wen Consulting, a technology solutions provider for the insurance industry, posted an interesting infographic on its Facebook page. It complied the average net investment returns on participating fund from major life insurers in Singapore.
To date, this infographic has been shared more than 200 times on Facebook, prompting discussion on major Facebook insurance discussion groups such as Insurance Discussion SG.
Source: Wen Consulting Facebook Page
Some observations we have:
- For whole life participating policies, insurers will project an investment return for the participating funds at 3.25% and 4.75% in its benefit illustration. The table above shows that for the most part, most insurers in Singapore are able to achieve a return within 3.25% and 4.75%.
- While the returns mentioned above are based on the overall average return for the participating funds from each insurer, they do not represent the individual returns on each sub-fund by the insurer. For example, most insurers have more than one fund. So it’s possible that while the table above mentioned that your insurer achieved a return of 4% for its participating funds for the past 10 years, the sub-fund which your insurance policy is tied to may be higher or lower.
The Biggest Misconception You Need To Avoid
There are many things that can be misinterpreted when looking at the benefit illustration of a whole life participating policy. We like to take a look at one possible mistake that consumers may make.
As mentioned above, projected investment returns are at 3.25% and 4.75% respectively. Under each of it is a column showing the “non-guaranteed” returns given if the participating fund achieved the projected investment return.
One expensive mistake here (literally) is assuming that 3.25% and 4.75% is the returns that you are getting.
This is grossly inaccurate. What the benefit illustration is actually saying is that if the participating fund achieves the 3.25% or 4.75% return, then policyholders will get the “non-guaranteed return” projected in the policy.
Death Benefit Vs Surrender Value
Another mistake is not realising that there is a significant difference between the death benefit payout (paid when you pass on) and the surrender value (paid out when you surrender the policy).
Here’s a quick comparison:
|Death Benefit (Projected at 3.25%)||Surrender Value (Projected at 3.25%)||Difference|
If we were to project the returns that we will have had we invested the premiums, our returns at age 75 would have been about $170,467, slightly higher than the death benefit projection of $163,770, and much more than the surrender value of $87,085.
This is of course a hypothetical comparison because investment returns should theoretically never be compared to death benefit payout (which is what we are doing here). Over time, an investment will increase in value while insurance payout for death benefit pays off if the policyholder passes on early. The two objectives are in contrast with one another.
However, what we want to stress here is that policyholder should look at their whole life participating policy as a life insurance policy, not an investment plan.
You Can’t Compare Whole Life Participating Policy Based On Its “Returns”
Lastly, we cannot just compare whole life participating policies based on the historical returns achieved by the participating funds.
Sure, it’s nice knowing that your insurer is likely to be able to achieve the projected investment return that they showed you. However, even achieving it doesn’t automatically means policyholders are getting more.
As pointed out above, the investment return achieved by the participating funds do not equate into higher return received by policyholders, be it through death benefit payout or surrendering of the policy.
Many other factors determine how much you ultimately get. For example, some whole life participating policies have critical illness plan tied to it, meaning that policyholders should expect less “returns” because the insurer need more funds for the wider coverage it provides.
Ultimately, the biggest takeaway here is that we should never treat a life insurance plan as an investment plan, even if there is a cash value component attached to it. Get the right life insurance plan that you need, rather than the one that has the highest return from their participating fund.