Den of The Lion Investor

Today, I will be sharing a case study of how I restructured my own endowment plan recently. You might want to do a similar review of your own plan and see how you can improve it.

My case study is based on a 20-year endowment plan (sum assured $20k) that I bought many years ago. For this plan, I had to pay $155.20/month for a period of 20 years and it will provide me with a coupon payout of $2000 every two years. These coupons could be reinvested with the insurer to earn attractive interest rates. There will also be a bonus that will be paid out upon the maturity of the plan.

At the point of purchase, the benefits illustration showed that I could expect to receive about $52902 upon maturity of the plan. This was based on the par fund achieving an investment returns of 6+%p.a. (estimated) and a 5.25%p.a. interest given on coupons reinvested with the insurer.

Based on my monthly premiums of $155.20, this gives an internal rate of return (IRR) of about 3.37%. If I had made my premiums annually ($1822.20) instead of monthly, the IRR would have been higher at 3.43%.

The plan also came with a couple of riders - critical illness (CI) protection and total and permanent disability (TPD). If I had done away with those, the annual premiums would have been lower at $1731. Based on this amount of premiums, the IRR will be even higher at 3.88%.

I then went on to calculate the IRR using the most recent projections given by the insurer. Obviously, it is lower. We are given projections from 3.7% to 5.7% for the par fund with the interest rate of the reinvested coupons ranging from 2.25% to 4.25%.

All the IRR results are shown in yellow in the table below. For my mode of payment (monthly with riders), my expected IRR would range from 1.58% to 2.85%.

The “Maturity Payout” in the last row shows the amount of money I would expect to receive (at different projection of par fund returns) if I reinvest all my coupons.

The last column is the original projection based on a par fund returns of 6+%.

To be honest, at the time I bought the policy, I know nothing much about investments. The plan was more for savings and the absolute numbers looked good then. Looking at the IRR now, they look a bit on the low side.

These are the things I went on to implement with the rationale given:

1. Change the monthly premiums to annual premiums. I save 2.2% every year and this beats the returns I’m getting from the banks.
2. Remove all the riders. The reason why I can do so is because I have other insurance plans that already provide sufficient cover for critical illnesses and TPD. It makes no sense to pay 5% more premiums per year for something I don’t really need (20k cover for CI and TPD). Furthermore, the purpose of this plan is primary for savings and not for insurance. Paying 5% more for an instrument that gives an IRR of 2-3% is a big deal.
3. Withdraw all my coupons that had been reinvested with the insurer. The current interest rate for the coupons is 3.25% p.a. and I am confident of beating this benchmark if I reinvest the money myself.

There you have it.

One thing I realised is that the circumstances of people change throughout the years. What is applicable in the past might not be applicable today.

Therefore, it might be worthwhile for you to go through and do a similar review of your current investment and insurance portfolio from time to time.

Being proactive about such matters can very well determine whether you achieve your own retirement goals as planned.

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The concept of insurance works on that of risk pooling. Premiums collected go into a common pool and are used to make payouts to claimants. The insurer manages this pool and will invest it to grow the size of the pool.

Holders of participating whole life or endowment policies are entitled to a share of the investment returns from this pool - we call this pool the participating fund or par fund. The returns are added to the value of individual policy holders every year via an annual bonus. Once this bonus has been declared, it is guaranteed. There is also a terminal (or surrender) bonus which will be given when there is a claim or when the policy is surrended.

An insurer might also have a few par fund for different classes of products.

In the past, the returns from these par funds are like a black box. No one (except the insurer) knows how they perform and the only clue you have is the annual statements you recieve which tell you how much annual bonus you have been given.

However since March this year, MAS has stipulated that insurers have to make known the performance of their par funds for the last three years in the benefits illustration. The expense ratio and asset allocation of the par funds also needs to be reflected.

A comparison of the performance and expense ratio of the par funds from three different insurance company reveals the following information:

Performance (% returns)

A : 2005 - 1.7%, 2006 - 5.9%, 2007 - 5%

B: 2005 - 13.2%, 2006 - 15.5%, 2007 - 12.3%

C: 2005 - 4.95%, 2006 - 8.39%, 2007 - 11.0%

Expense Ratio (percentage of the fund value that is spent on expenses)

A: 2005 - 0.08%, 2006 - 0.09%, 2007 - 0.09%

B: 2005 - 0.03%, 2006 - 0.02%, 2007 - 0.03%

C: 2005 - 0.23%, 2006 - 0.26%, 2007 - 0.31%

Clearly, there is a big difference in the performance of the different par funds.

If you look at the benefits illustration of an insurance policy now, it now shows your projected returns using two different levels of estimates for the returns of the par funds. For example, they might show projection based on 3.75%pa and 5.25% pa. This is a good thing as it will be clearer to the consumer that the returns are not guaranteed and also helps prevents mis-selling by the few over enthusiastic insurance agents.

Note that the returns of the par funds is not the same as the return you get on your investment. You will have to calculate your own internal rate of return based on the premiums paid and surrender value.

For example, a 5.25% projected returns of the par fund might show a guaranteed return of $50k and a non-guaranteed return of $15k for you. Your own annualised returns might be around 2-4%.

If the par fund performs better than 5.25%, your returns will be higher. And vice versa.

All these changes will help consumers better understand what they are purchasing when they buy an insurance policy. This is a step in the right direction.

In yesterday’s newspapers, there was an article about Tan Kin Lian, NTUC Income’s ex-CEO, mounting an online protest over some changes announced by NTUC recently.

The changes involve restructuring bonus payouts for life policies sold after 1993. Essentially, the annual bonus will be reduced but this will be offset by an increase in the terminal bonus.

What does all these mean exactly?

Before we go into that, let’s take a look at how a whole life insurance policy works.

When you purchase a participating whole life policy, your premiums go into a life fund that will be invested by the insurance company.

There are two things policy holders usually look at - the sum assured and the cash value (or surrender value) of the policy.

Depending on the investment performance of the life fund, you will be given a certain amount of annual bonuses that will increase your sum assured and cash value. This will be credited to your policy every year. Once an insurance company has declared these bonuses, they are guaranteed and cannot be removed.

If a person dies or surrenders the policy, he will also be given a terminal (or maturity) bonus. The amount of maturity bonus he gets will be dependent on the year it is given.

NTUC Income has announced that they will be reducing the amount of annual bonus that will be declared every year. They have reassured policy holders that their terminal bonus will be increased and in the end, it will not make much difference to them.

My Ken Ng, chief actuary of Income said that the change is necesary as it will allow Income to be more flexible with the investing of their life fund. Typically, when an annual bonus is declared, a certain portion of the assets has to be set aside in bonds to guarantee the returns. With a lower annual bonus, they will have more assets that can be invested in higher yielding products like equities. This will be better for policy holders in the long run.

The argument makes sense but the main danger to policy holders is that the terminal bonus is not guaranteed. What happens if the life fund takes a big hit during a particular year and the maturity bonus given out for that year is low? When that happens, there is nothing much you can do about it.

This had happened in the past with AIA before. In 2000, they annouced that it would reduce the terminal bonuses substantially.

I think it is unlikely that Tan Kin Lian will get his way as the insurance company has plenty of leeway in how they want to declare their bonuses.

However, the publicity generated by this event is a good wake-up call for consumers.

The moral of the story is to never purchase all your insurance cover from a single insurance company.

An insurance policy is a long term “investment” and unlike most other investments, you might not get another chance at it. In this case, diversification is even more crucial.

According to Health Minister Khaw Boon Wan, the Medishield insurance scheme currently pays only about 55 per cent of big bills in the subsidised B2 and C class wards. As he wants the patient’s share to be lower at about 20 per cent, therefore he is increasing some of the payouts under the scheme.

However, this also means that the premiums for everyone under the Medishield scheme will have to go up.

• If you are 60 and younger, your yearly premiums will increase by up to $60 from the existing $30-60.
• If you are 61-80, your yearly premiums will increase by up to $120 from the existing $225-510.
• If you are 81-85, your yearly premiums will increase by up to $480 from the existing $600-705. This is a more than 50% increase.

The people under the age group of 81-85 are the worst hit as their deductible amount will also rise to $3000 for B2 wards and $2000 for C wards. Those under 80 have a deductible of $1500 for B2 and $1000 for C.

(The deductible is the amount of money which you have to pay yourself before the Medishield insurance comes in. You will not be able to claim anything for bills that are below below the deductible amount.)

The reason given for the massive increase in premiums for the 81-85 group is that there is only a small pool of people (less than 6000) in that group, so it is difficult to keep costs down. With life expectency of Singaporeans increasing, perhaps there will be more people in that group in the future.

For myself, I have already ditched my Medishield plan long time ago to take up an alternative plan offered by one of the private insurers.

References:

ST article about the changes

Video by Minister Khaw Boon Wan on the premium increase