Insurance policies has evolved over the decades, ranging from pure protection to encompass savings and even investments. Term insurance, which typically offers 10, 20, 30 years of coverage has become cheaper, making insurance very affordable for everyone. Yet insurance products have also become more fanciful with many offering cash values such as whole life, investment-linked (ILP) and universal life policies, albeit more expensive forms of insurance. These policies have cash values that can be withdrawn or borrowed during the life of the policy or paid out at claims or maturity.

The question is: Are these cash value policies a good investment?

In other words, would I achieve better returns by investing more in, for example, whole life policies, or would it be wiser to opt for term insurance and invest the remaining funds?

To make sense of this, it is essential for you to understand these three fundamental principles:

1. Insurance Is Primarily for Protection, Not for Investments.

What is the overriding reason for getting insurance?

Certainly, the primary reason is because there is something we want to protect against, which is a financial risk. If you are a young working adult, you would want to protect against the loss of income, should a serious illness affect your ability to continue working. For working parents, having sufficient insurance ensures that their dependents can maintain their financial means to sustain a certain lifestyle should premature death occur.

Insurance is the only financial product that can provide the biggest payout in the event of death, medical crisis and disability. No other financial instrument can do a better job.

However, if your primary consideration is investment, then insurance policies should not be the first or only consideration. In fact, there are many options beyond insurance policies that could provide a better return. The investment return from insurance policies is typically lower due to the distribution cost (mainly sales commission) and the way the investment is conservatively managed (i.e. low risk, low return). Nowadays, there are plenty of low-cost investment options, such as investment Robo-Advisors and exchange-traded funds (ETFs), offering broad flexibility to customise investment portfolios to match your risk appetites and achieve better potential returns.

2. How Long Do You Need to Protect For?

This really depends on your insurance needs, and it can be easily categorised into two segments, namely Income Protection or Legacy Gifting.

Income Protection Approach

Under the Income Protection approach, the primary objective is to protect the most crucial period of your life when you are earning an income. In a hypothetical perfect world where sickness and death occur only at the end of the average lifespan of 85, how would you order your financial life? Typically, we would aim to retire by a certain age, say 60 – 65, and enjoy our golden years. To do so, we need to work and save from now till age 60 – 65. This period is crucial because any occurrence of death, disability, or a medical crisis would disrupt the ability to earn an income and, consequently, your retirement plan. Thus, it is essential to protect this phase of your life.

But how about protection beyond your retirement age?

There is no need to because by then you would already have enough retirement assets for the rest of your life, and you can certainly self-insure. In other words, having a claims payout beyond your retirement age is a bonus because you already have enough. Under the Income Protection Need approach, you focus on covering what is most important and needful. This approach will also help you to minimise your insurance premium, which is very important for the man on the street (see the following point).

Legacy Gifting

Under the Legacy Gifting approach, the objective is no longer about protecting income loss, but gifting a certain financial amount to beneficiaries, for example, $1 million to each child. To accomplish this, you would either need to set aside sufficient assets (e.g., cash, investments, property) from your wealth or purchase a whole life policy for a fraction of the outlay. Nevertheless, the premium for such whole life insurance remains a hefty sum, more suitable for the affluent who typically have more than enough.

3. What Types of Insurance Products Is Most Suitable?

For most people, term insurance is the most appropriate because it can cover the most crucial period of your working life (Income Protection approach).

Moreover, term insurance is more affordable than whole life insurance.

Let us use the following case study to illustrate:

Mr Tan, aged 40, drawing an annual income of $100,000, is looking for protection against death, total and permanent disability (TPD) and critical illness (CI).

Using a simple rule of thumb of covering 10x annual income for death/TPD and 4 times annual income for CI, Mr Tan needs $1m death/TPD and $400,000 critical illness cover.

Note: A pure whole life policy is less common hence a hybrid whole life is used instead for comparison

Observations and Comments

1. Both Option 1 and 2 provide the same death/TPD and CI benefits for the most crucial period of up to age 65. However, term (Option 1) is so much more affordable. At $1,783 of annual premiums, it is less than 2% of Mr Tan’s income. On the other hand, a whole life policy will set him back by $13,023 annually, which costs 5.7 times more. If Mr Tan has a family, his insurance commitments may also include his spouse and children, as well as other areas of protection not discussed here, such as hospitalisation, and long-term care, which will add to his insurance budget. Hence, term insurance is not only effective but also practical.
   
   
2. Suppose you are willing to pay for the whole life premium of $13,023 annually, would the cash value deliver a good investment return? To answer this, let’s do a Buy-Term-and-Invest-the-Rest (BTIR) comparison. Essentially, would the savings from buying term vs. whole life ($11,240 annually), if invested (4% p.a. for comparability), be better or worse off as compared to the cash value of the whole life?
   
   As shown in the table above, the BTIR ends up with a higher potential investment value as compared to the whole life case’s value. For example, at age 65, the investment value of BTIR is $486,824, which is higher than $306,114 from the whole life option.
   
   
3. To be fair, if there is a death or critical illness claim after age 65, the whole life policy could end up with a higher payout than the BTIR option, since there is still a $500,000 death and $200,000 CI benefit. However, people who advocate using whole life as an investment tend to consider “surrendering” it instead of withdrawing the cash value, hence the above comparison is still a reasonable one.

The Bottomline

Is there a place for whole life in your insurance programme?

At Havend, we believe the answer is yes, particularly when it comes to legacy gifting, where the longevity of whole life coverage surpasses that of Term insurance. However, when it comes to investments, insurance may not be the optimal avenue for maximising your returns.

Many of our core protection needs can be met using term insurance and using it correctly not only helps you to pay as little premium as you can but also get as much protection coverage as you need.

Do reach out to us for a complimentary InsureWell Assessment to find out if you are adequately covered with your existing insurance or overpaying for inadequate coverage. We promise to tell you if you have enough insurance and if that is the case, you need not purchase any insurance from us.

This is an original article written by Eddy Cheong, CEO of Havend.

At Havend, if we are found to have oversold you, we have put in place a Money Back Guarantee (MBG) scheme, so you can trust that we will always prioritise your interests first. Unprecedented in Singapore, learn more about our Money Back Guarantee scheme here.