Insurance policy returns can be confusing and misleading. Before buying a policy, remember these 3 facts.
One way insurance agents entice you to take up a life insurance plan is by showing the returns of your policy.
But your policy documents are filled with so many similar-looking lists of numbers. It can be difficult to even get an approximation of your policy's returns at maturity. Even if you dutifully note down the important numbers your agent points, you may get a different result - one that could be disappointing or even dismal.
To make it worse, insurance policy returns can be split up into several components, which makes for a confusing read.
All these mean that Singaporean policyholders can become misled into a false sense of security, holding a rosy view of their portfolio mismatched with reality. This problem became so prevalent that the authorities had revised the projected returns insurers are allowed to show their prospects, most recently in 2013.
It’s good the government keeps an eye on things, but it’s always better to be able to make an informed decision for ourselves, especially when it comes to personal finance.
Here’s what you should note when considering the potential returns of your policy.
You May Get Only Part of the Returns
Imagine if an insurance agent stopped you with an offer to give you S$3 for every S$1 you invest. You’d probably do a double take, but then quickly brush off the offer as too good to be true.
And you would be right - possibly.
Certain policies, especially annuities (or more popularly ‘retirement plans’) could very well provide a max payout that is several times your initial investment. However, you may not get the full sum.
Let’s illustrate with an example. Certain annuity plans are structured to give you a guaranteed payout for a fixed duration. If you survive beyond this period, you are entitled to receive a lump-sum bonus payout, also known as a longevity benefit.
It is the total of this longevity benefit and your guaranteed payout that gives you that impressive 300% returns. However, you have to outlive your annuity payout period to receive this sum. If you did not manage to survive long enough, then your actual returns become much lower.
Now, don’t get us wrong. We’re in no way saying this a bad thing. In fact, for the purpose of ensuring financial adequacy in old age, this could be a great plan, especially if the guaranteed payouts are sufficient to meet your needs.
The important thing here is to study the policy you are considering and ask questions until you are crystal clear about the conditions under which you will receive your payouts, or not. Only when you are able to explain your policy’s intricacies forward and backward, in Dothraki, should you then consider committing.
Your Policy’s Actual Performance Is Lower Than You Think
If you ask your agent about your policy’s expected returns, they’ll probably provide a range - between 3.25% and 4.75%. They will also mention that these are projected returns, while drawing your attention to the large numbers at the bottom of the Benefit Illustration.
Because most of us aren’t used to dealing with large numbers, much less calculating on-the-fly what an actual rate of return should look like, we tend to take the figures presented at face value.
However, the projected returns shown do not match the projected rate of returns, whether 3.25% or 4.75% - they should be much higher.
What you are looking at is the returns you get after paying for costs, otherwise known as Effect of Deductions.
Now, if you took the projected returns due to you (as seen in the Benefit Illustration) and calculated the rate of return, you’d end up with a figure that is lower than 3.25%. Sometimes way lower.
The true picture is this: your policy may indeed perform within the projected range, but you’ll have to pay for admin costs, commissions and other fees. This takes a large chunk out of the returns you receive, which means you’re getting a much lower return on your money.
So, the next time you catch yourself thinking 3.25% to 4.75% is a decent return, remind yourself that you won’t actually be getting that figure. Even if your policy performs better than expected, you still have fees to pay. You might want to check and see if your money might perform better elsewhere.
Your Returns Are Subject to Market Forces
Insurers sometimes like to present themselves as if your money will be handled by them alone. Unfortunately, that is not entirely true.
Granted, your insurance premiums are somewhat regulated in the sense that there are restrictions as to how they can be used. Consent must be garnered from policyholders before certain types of investments may be made.
The degree of risk which your premiums are exposed to depends on the policy you are on. For example, an ILP is riskier than a whole-life policy, all things being equal.
However, insurers make money by investing your money in the market and taking a cut of the returns. Which means that your returns are ultimately subject to market forces. Recall the panic that beset policyholders during the Lehman Brothers saga, when it emerged that AIG had a real risk of going under.
Ultimately, it behooves us to be smart with our money. Before buying an insurance policy, it is a good idea to do some research. Try and find out more about the insurance company that is issuing the policy, especially any lapses in financial practices, and how disputes were handled.
For the policy you are considering, ask for the historic returns of the past 10 years. No, not the projected returns, but what was paid out to policyholders in the past.
If you’re looking at an ILP, research the funds your policy is linked to, their historic performance, as well as policies for switching funds, and the associated fees.
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By Alevin Chan
A Certified Financial Planner with a curiosity about what makes people tick, Alevin's mission is to help readers understand the psychology of money. He's also on an ongoing quest to optimise happiness and enjoyment in his life.