As a lay person to insurance, it is not easy to ‘break into’ the knowledge banks of insurance. While I profess that I’m no way near a level where I can tell people what to do with their insurance, at least for now, I understand my own insurance needs and plans – which is the raison d’etre for wanting to know more about insurance.
Let’s just talk about the difference between a whole life plan and a term plan. A whole life plan is an insurance policy where the insured gets a cash value, usually towards the 3rd year of the policy. This cash value will grow in value, and it consists of two parts – the non-guaranteed part (usually projected at 3.75% or 5.75% pa) and another guaranteed part. The whole life insurance plan puts the premium that you pay into a participating fund (par fund for short). This par fund consists of a mix of assets, usually more geared towards bonds (higher percentage) and equities (lower percentage). Back in the heydays of bull markets, insurance policies of olden days project their non-guaranteed returns at a rate of 7-10% (that’s what I heard from others) and the selling point of these policies is the high cash values (as always, compared to fixed or savings accounts in banks) that the insured stands to gain when he cashes it out. I think it didn’t work out too nicely when the insured realized that the actual cash value is so far off the projected returns years down the road.
Well, on paper, anything goes. The best and most sophisticated model might not yield the most accurate predictions. Hence, for me, I never like to look at the non-guaranteed part of the cash value. It’s better to plan your life on not having the non-guaranteed portion than to have a shock in the future. This philosophy of not looking at the non-guaranteed portion of any cash values in policies extends not only to whole life but to other savings plans too. I just never look at the non-guaranteed part of the cash values. Call me a conservative if you wish.
To me, insurance is not about investment. I do not think highly of mixing insurance with investment. Obviously not everyone thinks the same as me, hence it’s crucial to decide how you treat insurance. As KK puts it, are you treating insurance as an expense or as an investment? If you treat it as an expense like me, you’ll want a cheap insurance with maximum coverage in terms of both breadth (i.e. how much coverage) and length (i.e. duration of coverage). You’ll not care for any cash benefits or returns because this is immaterial to your purpose of buying insurance. On the other hand, if you treat insurance as an investment, then you’ll want to worry about how much returns you are getting, and whether the returns are mostly in guaranteed part or non-guaranteed part, the composition of the par fund etc.
There are no bad insurance products, just a mismatch between products and the buyer. If you want to be serious in being financially independent, you’ll have to take responsibility in finding out more about insurance as it’s an integral part of being financially responsible to yourself and your family.
Now, what about term plans? Term plans, firstly, have no cash values to talk about. It’s purely for insurance and the premiums you paid are not put into the par fund to grow it. Hence, the premiums are usually much cheaper (around 4 times cheaper, all else being equal).
I think it’ll be good to list the comparison between term plan and whole life plans here: Read more…