27 June 2014

DIY Insurance - Buy Term and Invest the Rest

An often said advice about investing for retirement is to simply "buy term and invest the rest", rather than buying lots of endowments, insurance-linked policies and what not. The idea is to buy term insurance for protection, and invest the rest for retirement income (Bahamas anyone? Or Onsen in Hokkaido?). I do agree with this notion, provided that one is prepared to gain some appreciation about investment first. Else, one may in fact be better off going with those insurance based policies to fund protection and retirement.

Doing It Yourself

There is a portal recently started by Providend (Christopher Tan) for DIY Insurance. It offers price comparisons of insurance plans from various insurance companies. Pretty nifty. Although, the big ones like Prudential and AI are clearly absent.

I gave it a go and tried two profiles to examine how much the term insurance would cost.

20 Year Old

For a person at age 20, male, non-smoker. for a sum assured of $200,000 for death and total permanent disability, the annual premiums from various companies like AXA, NTUC Income and Tokio Marine were in the range of $294 to $315.

That seems doable for a young adult with a reasonable starting salary. For a fresh graduate or diploma holder (which is about 40-60% of each cohort), that would probably represent 10-15% of his basic salary.

Why would a young, presumably single person, need to buy such insurance? Well, it would be to provide a level of protection for one's dependents. Who might these dependents be? Could be parents, wife, and children. But more importantly, I feel that it is important to secure and have such a protection in place while one is still healthy and insurable - i.e. there are no exclusions or loading to the cost of insurance due to any pre-existing illness.

The challenge is, would a young person at this tender starting stage of his career, withstand the idea that 10% of his salary goes into an insurance for which there are no returns to be expected? The only return is only when one 'kaputs' - hits the jackpot to for early entry to the Pearly Gates! Touch wood. But this is insurance in the truest sense. Dealing with the unexpected.

45 Year Old

For a person at age 45, male, non-smoker, for a sum insured of $200,000 for death and total permanent disability, the annual premiums from various companies like AXA, Aviva, NTUC Income, Manulife and Tokio Marine were in the range of $728 to $916.

As one reaches this age, it would probably become more apparent why such a form of insurance is indeed desirable. There is now family to seriously worry about. Probably a few kids and schooling. Unfortunately, it is just as likely that by this age, one would be facing various illnesses and other complications - hypertension, diabetes, prior surgery, slip disc, etc.

From the above example, a $800,000 protection would amount to under $4,000 of annual premiums. As it is, I am paying an average of $2,000 a month on average, to achieve the equivalent protection, with investment components projected to achieve a return of $750,000 by age 62. That's $24,000 per year!

Regrets and Realisation

I would have been better of paying the $4,000 in annual premiums for the term life insurance coverage of $800,000 and take the remaining $20,000 to invest. As it is, I've been achieving an internal rate of return of 20% for the last few years of investment. Realistically though, I am only expecting 6.5% over the longer term. Regardless, I do believe that I would have generated a far better rate of return than what I'm actually getting now from the endowment and ILP insurance plans.

Had I understood this better when I was young, the premium would only have been even lower, at $1,200 a year, for the term life insurance coverage of $800,000. Wow! Missed opportunities. Quite an opportunity cost.

Over time, as one's investment grows, the need for term insurance actually will taper down since the investment component will make up the shortfall. As the kids come of age and starts working, one only need to protect the spouse. And when the whole investment portfolio has reached the point of financial independence, there is no longer a need for any term insurance coverage even.

With that, my take is that I should have bought term insurances with different timelines. If I could wind back the clock, this is what I would have done:

Age 24 - started work - buy $200,000 term for 30 years (ending age 54)
Age 27 - married - buy another $200,000 term for 30 years (ending age 57)
Age 30 - 1st child (boy) born - buy another $200,000 term for 25 years (ending age 55)
Age 32 - 2nd child (girl) born - buy another $200,000 term for 23 years (ending age 55; girl doesn't need to serve NS, so it's 2 years less)

Amount may have to be more, depending on the lifestyle to maintain. But the idea is to provide enough coverage with each additional dependent, and to cover the kids only until they start working. They ought to be making a living and contribute to the family right?

It would be really silly for a person to hold a term insurance when one is no longer working. After all, the protection is to deal with loss of income isn't it?

And as one ages and builds up an investment portfolio, the term insurance is only to make up for the shortfall to achieve financial independence for the spouse. The math is really simple, though a spreadsheet would certainly be a big help.

In Conclusion

Buy term, and invest the rest!

And oh yes, maintain a hospitalisation/medical insurance! Looking forward to clarity on the enhancements to the CPF Medishield scheme.

Caveat: The figures are illustrative and may differ depending on individual conditions.

p/s: I am not an insurance agent nor a financial advisor. This is purely my personal opinion and hindsight views for my personal and family's considerations.


Anonymous said...

Hi Lizardo,

Why would you prefer for term coverage to end around the age of 55?

I took up a term insurance which covers me up to 75! I even had a friend who took up a $2mil term coverage up till the age of 100?

best regards,

Lizardo said...

Hi naro,

My view on term insurance is that it's to protect against the lost income upon death. It's to protect the dependents. There is an assumption that there is an investment portfolio being built up. There is hence much lesser need to depend on the term insurance to make up for the shortfall.

In my explanation, I assumed the children would have started working about that age as well. Hence, they would no longer be dependents and can in fact contribute towards the family should something unforeseen happen.

I do not plan on the term insurance providing fully for my children in their adulthood. They need to develop the attitude that there is no free lunch and have the will and motivation to work for theirs.