Your Money or Your Life

Financial awareness remains rather low among Singaporeans. In money matters, many of them still make quite basic errors. This article illustrates.

ST Nov 11, 2006
Many S'poreans don't have the right insurance cover
A third of those surveyed can't tell what is sufficient level of protection

By Finance Correspondent, Lorna Tan

ALMOST nine out of 10 Singaporeans have an insurance policy but many of them remain grossly underinsured when hard times hit because they have not bought the right policy.

A recent survey by the Life Insurance Association (LIA) found that 35 per cent of 514 respondents had no clue about what constituted a sufficient level of cover.

The most popular policies in Singapore have long been whole life and endowment plans. They have costly premiums but offer some insurance protection and potentially bumper payouts.

The high premiums, however, tempt many people to settle for a lower level of insurance cover that in many cases is inadequate.

According to the July survey, which covers households with a monthly income of at least $3,000, 73 per cent of respondents bought whole life policies, while 59 per cent have endowment plans.

LIA figures also show that the average death payout this year has been just $39,700.

And the average claim payout - anything from policy maturities, death and critical illness to total and permanent disability - was a mere $29,000.

Experts like Mr Christopher Tan, chief executive of financial advisory firm Providend, believe that many people would be better off investing in more traditional term life plans.

These offer pure insurance protection but have no savings element, which means there is no payout when the policy expires or is surrendered.

You don't need to be an expert like Christopher Tan. All you need is buy a basic book on personal financial planning and you will quickly understand that the advice "buy term, invest the rest" is good advice for most people. Not all people, but most people.

To give an idea of costs, a 20-year term plan with a sum insured of $100,000 costs $391 a year for a 35-year-old non-smoking male.

This is much lower than the annual premiums of $1,990 for a whole life policy and $4,559 for a 20-year endowment plan.

LIA deputy president Mark O'Dell recommended term plans, with their high protection at a relatively lower cost, as 'the most affordable way for families with dependants to close the protection gap'.

Yet these plans are not big sellers here and one reason, said Mr Tan, is that agents reap higher commissions selling whole life and endowment plans.

He said: 'At the end of the day, if the main compensation is commissions, there is a high chance that whatever product is sold depends on the commissions derived.'

This is one important reason why we all need self-education on how to manage our own money matters. Financial advisers and insurance agents, first and foremost, sell you products and policies that are good for themselves. That's often not the same as what's good for you.

The LIA cited another reason. 'Singaporeans, like many people in Asia, like combining protection with investments, knowing that there will be a cash value when a policy matures,' said LIA president Jason Sadler.

Well, let me perform my public-service good deed for the day and explain a couple of things.

Suppose you want life insurance, so as to protect your loved ones from financial disaster should you unexpectedly die. At the same time, you also want to invest your money. So you buy some kind of investment-linked policy which achieves both objectives at the same time. Your insurance agent collects a big commission and both of you are happy.

In practice, this is usually not the optimal approach for you (although your agent will be happy). In most cases, the better approach for you is to buy term life insurance and separately invest your money.

Term life insurance is basically a kind of insurance where you pay a small premium every month for a very large payout if you die. You usually cannot buy term life insurance beyond the age of 65. If you don't die by then, you don't ever get any money back.

If/when you pass the age of 65, chances are that your dependants are not very dependent on you. Your kids will probably be grown up. By then you will also hopefully have built up your savings and you can pass it all to your beloved spouse after you're dead.

The monthly premium for term life insurance is very cheap, compared to, say a endowment plan or a whole life policy. Thus for most people, buying term and investing the rest works better. That way, you get a lot more protection. You also get an excellent chance of achieving better investment returns in the long run.

That's because the nature of many endowment plans is that they have to be very conservative about how they invest your money. Low risk translates into low returns, which is unfortunate because these plans run on for years and years. With a long timespan, people should logically take higher risks - another basic financial concept.

Of course, I've assumed above that you are willing to put in some effort to learn how to invest your money elsewhere in a sensible way.

Moving on. Now here comes a little bit of bullshit, [sales pitch] piece of advice that Mr Wang disagrees with:

But to have sufficient protection, he said the 'international rule of thumb' for insurance cover for an individual should be at least 10 times his annual earnings.

Whenever you hear any piece of advice about anything concerning money, first ask yourself - what is the source of this piece of advice, and what agenda would this source have?

The international rule of thumb for insurance is that you should have "at least 10 times his annual earnings" - so we're told. This "rule of thumb" is created by insurance companies, whose agenda is to sell you insurance. That's how they make money. So you can be quite confident that their rule of thumb has probably been heavily overstated.

Firstly let me explain the rationale behind this rule of thumb. Suppose you are the sole breadwinner of your family and you earn $5,000 a month or $60,000 a year. Then you die. The idea is that your insurance payout should be sufficient to allow your family to sustain approximately the same lifestyle for the next 10 years. That will give them plenty of "cushion" to adjust to your untimely demise. So the insurance agent will say that you need to have $60,000 x 10 = $600,000 worth of coverage.

Now, as you can see, there is some "rationale" behind the rule of thumb. On the other hand, it also glosses over many variables, which are collectively so significant that I, for one, think that the rule of thumb is largely useless.

Firstly, if you were earning $5,000 a month today, you wouldn't have spent it all on your family anyway. Suppose in fact that on average, you had been spending $1,500 a month on yourself (food, transport, clothes, entertainment). Well, when you're dead, you don't need any more food, transport clothes or entertainment. In fact you've been sustaining your family on only $5,000 - $1,500 = $3,500 a month, or $42,000 a year. Reapplying the adjusted rule of thumb, you only need $42,000 x 10 = $420,000, not $600,000 worth of coverage.

Secondly, receiving the full sum of $420,000 immediately upon your death is very different from receiving $3,500 a month, 12 months a year, over 10 years. Don't forget the time value of money. The immediate $420,000 is much more valuable. If what you want is for your family to receive the equivalent of $3,500 every month for the next 120 months after your death, and you therefore proceed to pay for the right to immediately receive $420,000 upon death, you are basically overpaying.

Thirdly, consider the hypothetical Mr Jin Jia Kiam and Mr Ai Kai Lui, both of whom are about the same age, currently earning $5,000 a month and spending $3,500 a month on their respective families (one wife and two young kids each). Suppose both men die. Mr Jin dies leaving $300,000 in his bank and investment accounts. Mr Ai dies leaving $300,000 in credit card and loan shark debts. Obviously, they leave their families in very different financial circumstances. Thus what constitutes adequate insurance coverage would be very different for Mr Jin and Mr Ai. Since individuals can be vastly different in their financial circumstances even though they earn the same salary, the "10 times annual earnings" insurance rule of thumb is quite useless.

Fourthly, even if you had not died at that critical moment, your salary would not have remained the same (at $5,000) for the next 120 months anyway. Do you actually know anyone whose salary has actually stayed the same for the past 120 months?

I could give more examples, but by now you get the point. I'll say it again - there are so many significant variables that this insurance rule of thumb is pretty much useless. What people need is some basic level of financial understanding, so that they can consider the variables in their own individual lives, and plan accordingly. The rule of thumb SUCKS. And everyone should educate themselves on how to manage their own financial matters.

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