Last week my insurance agent sent me the most intense word game ever. It kept me occupied for three hours; then I realised it was the terms and conditions. Let’s face it: Insurance has become like gravity. We all know it’s there and important. We’re just utterly clueless about how it works. Here’s the most simple, basic things you need to understand:
What is Life Insurance?
A requirement when renting vacation homes on Craigslist. Also, a financial product that provides a payout should you experience serious illness, permanent disability, or death (in which case it’s a payout to your dependents; your use for it will be a bit limited at that point).
The price of an insurance policy is the premium. This is the sum you pay every month or annually, and is determined by a variety of factors: Age, health, family history, how entertaining you find Jackass videos, etc.
The insurer will determine your susceptibility to various risks, like cancer, heart disease, industrial accidents, etc. They then vary your premiums to match the risk, which means the cost of premiums for each person is highly variable.
Note that, besides insurance companies, all Singaporeans are already insured under a government healthcare scheme (Medishield Life). Payouts from private insurers can be used to complement Medishield payouts, depending on the circumstances and policy terms. If you are still confused, you can contact us and find out more here.
Why Is It So Complicated?
Many years ago, insurers realised that few people like buying their product, because:
(1) Old people tend to have high, unaffordable premiums, whereas people below 30 often suspect they’re immortal.
(2) A lot of people wonder: What if nothing happens to me? All those premiums I paid will be wasted.
So insurers started adding extra features, like having policies double as savings plans and investments.
Most insurance policies today don’t just pay out in event of disaster. They also grow the money paid out in premiums, and give you a lump sum after a number of years. Think of them as alternatives to bank savings deposits.
These extra features are (take a deep breath, this will shock you) not free. They generally mean higher premiums. In addition, insurance agents and companies will take a cut of the returns.
So when buying a policy, it’s up to you to shop around, think things through carefully, and decide if insurers are worth their price. While you’re at it, these are the three general kinds of policies insurers will try to sell you:
- Term Insurance
- Life Insurance (Endowment)
- Invest Linked Policies (ILPs)
1. Term Insurance
This is the oldest, most basic form of insurance. It is to the insurance industry what budget airlines are to the aviation industry: Economical, dull, and best suited as the punchline of a Dilbert strip.
Term insurance comes with an expiry date. This is the fixed term. This period lasts anywhere from five to 40 years, depending on the policy. Should you suffer critical illnesses*, permanent disabilities*, or death during this time, the insurer will pay out the agreed upon sum.
*Not all term insurance policies provide such coverage. Check with the agent in question.
There’s no savings or investment component in term insurance. Once it’s expired, the premiums spent are gone. But that doesn’t mean it’s bad:
Term insurance is the cheapest type of policy. Its premiums can fall below double digits. And part of our populace are strict believers in term insurance only: They pay the lowest premiums, and grow their money through other means (stocks, property, Forex trading, etc).
Mind you, if you’re the sort who thinks P/E ratio is a grade for Primary school phys. ed. classes, maybe this isn’t for you. Also note that, because premiums are lower when you’re younger, people below 30 should consider buying a policy with a longer term.
2. Life Insurance (Endowment)
Endowment policies are a cross between a savings deposit and an insurance policy. Stretch your imagination really hard, and imagine a banker who cares about your family.
Now that you’ve stopped laughing, I can tell you endowment policies have maturity dates. These are typically 10, 15, or 20 years. The maturity date may also be pegged to your age (e.g. it matures when you reach the age of 55).
Endowment policies pay a certain sum to your dependents, should you die* before the policy matures. If you make it to the maturity date without incident though, you get a lump sum payout.
This lump sum depends on whether it’s:
- A Par (Participating) Policy
- A Non-Par Policy
- An ILP, as described in point 3
Par policies have two components: An assured sum, which is paid out upon death* or maturity, and a variable bonus. As to how this variable bonus is figured, you will have to ask the insurance agent in question; every policy varies significantly.
Note that the assured sum (excluding the variable bonus) may amount to less than the total premiums you’ve paid. It is not like a bank’s fixed deposit, where you get to take out every cent you’ve ever put in. (You’re paying for protection as well).
Non-par policies only pay out an assured sum, upon death* or maturity.
For ILPs, see point 3. You should also check out the surrender values of the policies: If you surrender them before the maturity date, what will you get back? The answer can actually be nothing, and you could end up with the equivalent of my ex-girlfriend (Years of commitment with no reward).
Endowment policies are best used to meet specific targets. For example, if you’re 25, you might want a 10 year endowment policy so you can meet the downpayment on a flat. The downside to endowment policies, of course, are the higher premium costs, and the fact that bonuses are variable.
*Endowment policies may cover other conditions besides death. Check with the insurance agent in question.
3. Investment Linked Policies
These are insurance policies that double as investments. When you pay premiums for an ILP, some of the money is used to buy units in various funds.
The list of available funds will be presented by the insurer, and you get to choose. Of course, most people who have the knowledge to pick funds would be using term insurance, so I’m not sure what the point of this is…but you get to choose.
Now, like any other insurance policy, ILPs pay out in the event of death (or any of other conditions in the coverage). But the pay out is the higher of an assured sum, or the current value of the ILP units (those funds you buy with the policy). In some policies, it may be a mix of both; check with the agent.
Because this is not complicated enough, there are also single premium ILPs. These are policies where you plonk down a single lump sum, instead of paying ongoing premiums. This makes the policy cheaper overall, but tends to shrink the insurance protection.
Because ILPs invest your money in the open market, you should expect payouts to fluctuate. They also tend to be more expensive, because the funds are often be actively managed; that means a portion of the returns will indirectly go to a fund manager somewhere (the guy who does the buying and selling for the fund).
ILPs are complex investment products, on top of being life insurance. If you’re sure you want one, I’d suggest you find an independent financial adviser. You can also follow us on Facebook, and we’ll update you as the industry changes. If you’re interested in finding out a bit more about one or more of the things we’ve highlighted above, just contact us here and we’ll help you through the maze of life insurance.
What sort of life insurance do you consider essential? Share your thoughts with us here.