When I started out my career as an insurance adviser many years ago, I was taught that insurance is a good instrument for accumulating one’s wealth. Not only does it gives a higher than bank interest rate, offers protection against death and disability, but it is also a systematic and organised way of savings. It is not until many years later that I found out it was only half the truth.
Today, I still hear many preaching this distorted gospel. Even financial advisers make this same mistake. In this short article, I hope to dispel this myth that many have believed, for a long time.
For those who advocate the use of insurance as a savings tool, these are some of their reasons:
1. Higher interest rates than bank
Currently, bank interest rates are at all time low. Instead of leaving your money in the bank, you should park your money with insurance companies that will give you a higher return for your funds.
2. Additional protection
Besides getting a higher return for your money, you get additional protection. In the event of your death, disability or even if you are diagnosed with a major illness, your objective of accumulating towards a certain financial objective can still be achieved. This is because; the insurance policy you own will pay a lump sum to you or your loved ones.
Besides accumulating your money at a higher interest rates and having the protection element, your money is being invested in a safe instrument.
To be fair, there is some truth in what is being said about using insurance as a savings tool. It does give a higher interest rate than the bank deposits. It does provide you with the protection. It does, to a certain extent provide a safer haven for investing. However, they are simply half- truths. Before you decide putting your hard earned money into it, you would be better off seeing the full picture. Consider these points:
1. No liquidity
Yes, insurance does offer you a higher interest rate than bank deposits. However, as the saying goes, we are not comparing apple with apples. Bank deposits are meant for short term parking of your monies. They are meant to be liquid, which means you can get it out without any loss of capital in the shortest possible time. They are also flexible in that there is no commitment to continue depositing monies into your account. They naturally come with a lower interest. Insurance is a long-term instrument. It is not as liquid as cash in bank. If you need money suddenly, or you need to stop your contributions (premiums) you most likely will have to suffer a loss if you cash it out. Of course, you need not surrender the policy but instead take a policy loan, but it comes with a cost. You need to put back what you take out plus interest of around 7-8% depending on different insurance companies.
2. Protection comes with a cost
Yes, insurance does provide you with the additional protection against death, disability and even major illness. However, it does not come free. You have to pay for it. Do you know that every single dollar that you pay for your insurance policy goes to your agents as commissions, to the insurance companies as mortality charges (that is the cost of insuring you) and whatever is left is than being invested? So don’t think it is free. Not that I am against paying for the insurance, but rather the crucial question we need to ask ourselves is:Do we need that additional coverage in the first place? If your answer is yes, is this the best way to do it? If the answer is no, then you should not be paying for something that you do not need.
3. Exposed to equity market as well
Yes, insurance does to a certain extent provide you with some safety. Part of your maturity benefit is guaranteed. But do you realised that most of the time, the guaranteed component is such a small component of the overall benefit? Compared to what you have invested, plus your opportunity cost, you would have lost money big time. Besides, your monies placed with the insurance companies are also being invested in the stock market, bond markets and so on. They are also subjected to market risk.It is no surprise that over the last few years, when the market was bearish, that many insurance companies adjusted their bonus rates downwards.So insurance being a safe instrument may be a perception after all.
4. No flexibility
Besides all the above, if you decide on using insurance as your savings tool, you have to accept the fact that you will have to forgo flexibility. The flexibility to stop saving if you cannot for some good reason, the flexibility to change fund manager if it is not producing the results you want, the flexibility to cash out all your savings if there is an emergency. If you have to do all that, you must either lose coverage or lose money.
SO WHAT ARE YOUR ALTERNATIVES?
Having known the whole truth, what can you do? Well, first decide whether you need the insurance in the first place. If so, separate your need for insurance from your need of having to invest or save your money. For the insurance part, buy an insurance plan that is without profits,non-participative or even a term plan according to your needs. Simply put, whether you need insurance to cover you your entire life or for a fixed number of years, pay only for the protection part of the insurance and nothing extra. For the savings part, invest it directly using unit trusts or equivalent instruments. If I have not been clear, let me illustrate it in another way. Instead of using a dollar to buy an insurance policy to save towards your goal, of which from the dollar, twenty cents is for insurance cost and eighty cents is for the insurance companies to invest it for you, buy twenty cents of insurance and invest the eighty cents yourself.
The problem with buying a “without profits” insurance and investing the difference yourself is that you do not invest the difference! Than it may be better off letting the insurance companies invest it for you. Another problem is that you do not invest your money properly. With that I mean, buying stocks if you do not really understand the stock market, buying flavour of the month unit trust and so on. In a nutshell, you do not create a diversified portfolio with a suitable asset allocation, and you do not monitor your investments closely and constantly rebalance your portfolio.
But if you are engaging an adviser to help you, which I suspect most people do, you must at least expect your adviser to be able to help you construct a portfolio and monitor it for you. If he cannot even give you certain level of confidence in managing your investments properly, I think you have gotten a wrong adviser.
If one depends solely on using insurance as a savings tool to reach your financial objective, you either have to set aside a lot of your income each month to accumulate or you may only be able to achieve it after a long while. We all know that insurance simply gives a higher interest rate than bank deposits. Beyond that, the returns are not exciting. This is because, as the name implies, insurance is insurance. It is a protection tool and not a savings tool. Unfortunately, putting money into life insurance and investments is a zero sum game. The more you put your money into life insurance, the lesser you have to invest to achieve your financial goals. If you are able to use the correct instrument for the correct purpose, that is if you learn to separate protection from investment, you may have a better chance of achieving all your financial goals.
The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-only Retirement Financial Adviser. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation.