Photo Credit: Mikey
Mr Tan Kin Lian kept a very good FAQ on personal insurance. Being an ex-CEO of an insurance company, he actually do not believe in buying whole life insurance policies and advocated buying term and invest the premiums saved in low cost funds.
There are a few guidelines he proposed when planning your personal insurance:
- Cover for 5-10 years of your earnings (based on your dependents, budget and amount of savings)
- Less than 2% of your income (or less than 3% for your entire family)
- No need for life insurance after age 65
- Critical Illness cover not necessary
I have been convinced by him and decided to evaluate my insurance policies altogether, eventually came to a decision to terminate my cash value policies. I am not blindly following but I have my reasons:
Time is on my side
I am young and plenty of years ahead of me. Hence, the compounding effect is going to be greater to me than those older than me. This means that my opportunity cost for higher rate of returns is higher. Based on Mr Tan Kin Lian’s calculation, you can reduce up to 80% in investment returns for a whole life policy:
“The typical cost of an endowment or whole life policy is a reduction of 4% to 4.5% in the yield.
If the long term investment yield is 7%, a reduction of 4.5% gives you a net yield of 2.5%. This net yield is unsatisfactory, as it is not likely to cover the rate of inflation. You need to aim for a higher yield.
If you select a low cost insurance fund, the reduction in yield should be only 1%. This allows you to get a net yield of 6%.
If you are investing for 20 years, a difference of 3.5% in the yield (i.e. 2.5% from a life insurance policy compared to 6% from a low cost product) accumulates to 44% at the end of 20 years.
If you invest for 30 years, the difference is 80%,
For example, instead of getting cash value of $100,000 at the end of 20 years from a whole life policy, you could get $144,000 (i.e. 44% more) by buying Term insurance and investing the remaining savings in a low cost investment fund.”
Looking at the compounding effect, I have decided to put the premiums saved from my policies into STI ETF
every month. STI ETF is indeed a low cost fund with reasonable yield (I expect around 6-8%).
It is not easy to take the path less traveled but I am proud that I am able to walk the talk – practise what I preach. I understand there is some risks attached to it but I am ready to take full responsibility of whatever outcome in the future.
Situation has changed
Initially, I took insurance premiums as a means to force me to save every month. I was quite a bad saver back then. After internalizing sound financial principles, I must say I have become a discipline and responsible user of money. Due to this transition, I felt that I am ready to progress further in the journey of financial freedom. Now every cent becomes a resource for me to utilize and deploy for maximum returns.
Warning! May not apply to you…
If you are not disciplined to put the premium saved into a low cost investment fund regularly, then you are better off buying a life insurance policy to force you to do it. Secondly, if you do not have an investment horizon of 10 years or more, you are better off sticking with the life policy that you have.
If you are rich, this does not apply to you too. This is because you do not need to take on additional risks to invest in more volatile instruments. A life policy would make more sense. My insurance agent friend told me that a million dollar contract may cover him for 4-5 million dollars. Hence, if a person who has $5 mil, he can buy a million dollar contract and leave $5 mil for his children while spending the remaining $4 mil for retirement. It is a much sound method. Hence, personal finance is really personal - everyone’s situation is different.
My intent is to show you how financial decisions made now can have significant impact in the future. You may not agree to my plans but I think it is worthwhile to give some thoughts about your situation.
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{ 4 comments… read them below or add one }
I think you check out more about Mr Tan before you follow his advise.
He is an interesting man and I will not elaborate more here.
2 questions
I think you check out more about Mr Tan before you follow his advise.
He is an interesting man and I will not elaborate more here. If you have seen an article on Straits TImes, he mentioned he is willing to run for President Of SIngapore if he received sufficient votes.
No offense but I personally think he is quite funny.
4 questions to consider here when you want to
1) After 65, when your term policy ends, if you are hit by critical illness, will you like to have a pool of money to have self independence or would you rather rely on your children or your savings for your retirement.
2) After 65, when you term policy ends, do you want to die for free or you want to leave something behind for your love ones when you are gone?
3) How sure are you in making a return on your investment? Can you confirm you can be immune to the emotional rollar coaster when you see the ups and down of your investment?
4) How certain are you in risk transition across your life stages when you approach retirement? This will mean you will need the knowledge, the time and the effort to do so.
In summary, I’m not saying that one should not invest. If you understand the word portfolio allocation, you will know what I mean. Similarly, if you think you can self medicate after reading sufficient information from the abundance found on the internet, why are there still doctors around?
Everyone and every program/plan has a role to play.
So in conclusion, I disagree strongly with Mr Tan’s opinions.
Just my 2 cents worth
I believe everyone has his/her perspective over insurance. There is no right or wrong way to do things. Here are my answers based on my own perspective on the 4 questions you raised:
1) The purpose of having better ROI is to raise enough money (even more than the sum assured) in the span of working years to cover for any emergency after 65 years old.
2) Same as no. 1 It is about having more money after 65 with an investment with better returns.
3) That depends on the investor. But importantly, you must feel confident and have faith in what you do. Just like you have a lot of faith in insurance. If one is not confident, then he/she is better off buying insurance. I agree with you.
4) I do not quite understand your question, but I will still need insurance to cover me while I have the ability to earn an income.
I agree insurance is a must and is critically important when we are in our prime days earning income. We must protect our wealth accumulation period. That said, it means that we likely need to cover us for this interim period with insurance that is as low cost as possible, so that we can channel our funds to investment with better returns. That is my take on insurance and you may disagree with me.
HI Alvin,
yep, its indivdual’s opinions. At the end of the day, if one is ready to take up the consequences of his or her decision, then its ok. My role is to show and evaluate the cost and consequences of the different options.
I understand your take on a lower cost insurance so that you can channel your funds elsewhere to achieve a high ROI.
Yes, insurance (lump sum payout) is to come in to replace one’s income during their prime years when one is unable to work. It serves as a first line of defence when something happens. Since resources are needed to carry on investing (whether its DCA or Lump sum), we then need to determine where these resources are coming from?
Majority of these resources should come from work in the earlier years, (Assuming that you did not inherit a big capital from somewhere) and in this relationship, the man works and earns the resources.
The issue is, what happens when the man is not able to work and have used up this lump sum payout (from term) but not able to recover to 100% and therefore not able to carry on to work, earn an income and accumulate and invest elsewhere?
This may happen when:
1) Your illness relapse (Especially common in cancer)
2) Your illness last forever (Eg: kidney failure)
If any of this 2 situation happens, what will happened to the funds you ought to accumulate (through investment or other means) when you retire?
As such, not only we need to build on a first line of defence, we need to build a second line of defence, ie funds after retirement.
If one is only to buy a term and invest the rest, what will happen if 2 of the situation occur in the prime young age?