Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Insurance 101 Guide

















Insurance 101 Guide  
The guide that teaches you how to get cost efficient insurance coverage





















First published 2015


Insurance 101 Guide
Copyright © 2015
All rights reserved.


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Dear Distinguished Subscribers,

Thank you for supporting us, our blog, and for reading our financial-related posts. It is because of you that we were able to consistent grow our viewership in a matured blogging space.

As mentioned in the previous blog post, we have been busy gathering more information about Direct Purchase Insurance (DPI), an insurance initiative launched recently by the Monetary Authority of Singapore (MAS). For personal reasons, we have spoken to investment advisors, insurance agents and attended a talk organised by a DPI provider (DIYinsurance), all to better understand how we can minimise our insurance cost while maximising coverage.

We would also like to thank and credit Mr Christopher from Providend organising the DIYinsurance talk. The talk was extremely informative not only about the new initiative but also about insurance coverage everyone should have. You can visit his website at: http://www.providend.com/ and http://www.diyinsurance.com.sg/portal/home/index.jsp. You can also visit our website http://investmentstab.blogspot.sg/ for more information.

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Disclaimer
The below content is just an opinion and may not be factual. It is not intended to be any representation of any sorts and should individuals want to obtain any form of financial instruments as discussed below, they should consult their respective authorized advisers. Any opinions expressed in this report are subjected to change without notice and any affiliated sites or authors are not under any obligation to update or keep current the information contained herein. Any references made to third parties are based on information obtained from sources believed to be reliable, but are not guaranteed as being accurate. This report has no regard to the specific investment objectives, financial situation, or particular needs of any reader. Information, tools and articles published are solely for informational purposes and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments.

The author of this report shall not be liable for any damages or losses incurred as a result from the below content and users are to exercise caution and their own judgement when using these information.
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As you all know, insurance is something you pay for but hope that you never have to exercise it. It is a transfer of risk from you to your insurance company. Before you buy any insurance, you must first determine how long you should be covered, how much to be covered, and what type of insurance to buy. However, I would like to add the last step: who you buy your insurance from.

For the sake of simplicity, this article does not take into account the future value of the each cost. This is also a simplified classification of insurance that is meant for easy understanding of the product.

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Life Insurance

What is Life Insurance?

Life insurance is an insurance you buy for your dependents (beneficiary) when you are alive. Upon your death, the beneficiary will receive a sum of money (benefits). The sum of money is meant to replace your family’s loss of income in the event of your death.

1.     How long should your coverage last?

It is recommended that the insurance should last either till your retirement or until the age your dependents are financially independent of you, whichever is later. You may also choose to cover for your spouse’s livelihood for the rest of their life although it is rarely necessary.

               Illustration 1:

You have a family of 3 children age 21, 18 and 13. Assuming they will be financially independent after they finish their university, approximately age 24, you will have to plan and provide for them 11 years’ worth of coverage (24 minus 13). You may also wish to include a plan for your spouse’s future living expenses. You will need insurance to provide a source of income for your family during the period where a mishap impairs your ability to sustain your family’s lifestyle.

Illustration 2:

You and your spouse have retired and your kids are already financially independent of you. You wish to ensure your spouse’s livelihood is not impairs in the event of your death, thus you extend your life insurance coverage period.
However, when you reach your retirement, you will usually have a retirement fund for both of you, and you spouse could rely on your kids for extra support. Thus this extended insurance is rarely required.

  
2.     How much should you be covered for?

To determine how much you should be covered for, you need to evaluate your family’s current and future expenses. This varies from person to person, but they typically consist of loans (mortgage, car and credit card), dependents’ future education cost, and monthly living expenses. The monthly living expense is often the more important factor and the insurance should be planned to ensure minimal drop in your family’s standard of living.

               Basic costs that you should take note of:
  1.  Current debts (or predictable future debts that you are going to undertake)
  2. Current income (or income providing satisfactory quality of life)
  3. Future obligations (eg. Dependents’ education)

After determining all the “cost” you have to cover, take that amount and minus away the coverage and savings you currently have. Examples include mortgage insurance (pays off your mortgage in the event of your death) and your savings and investments. This is an extremely crucial stage as you must check carefully what coverage and other sources of wealth you have to ensure that you do not overly insure yourself unnecessarily.
  

Illustration:

You are currently 30 years old, married (spouse age 30) with 1 children age 5. You would like to cover your family until your spouse retires at age 65. Your finances and how much you need to be insured will look something like this:

Item
Amount
Total



Mortgage Loan
200,000

Car Loan
20,000

35years Living Expenses
630,000

Children Education Cost
20,000

Total Sum Required

870,000



Mortgage Insurance
200,000

Savings
15,000

Investment
20,000

Total Surplus

235,000



Required Coverage

635,000


Base on the calculations, you would be required to insure yourself a sum of $635,000 to ensure your family is not affected by the loss of income that comes with your death.

These calculations are based on the assumptions:
·        Zero inflation rate (for simplicity purposes)
·        Monthly living expense of $1,500
·        Children not going to college
·        Funeral prices are not included as it varies based on personal preference. However, it is best estimated to be $6000 as an average.

              
               * For Singapore readers, do check your Central Provident Fund (CPF) on what coverages you currently are opted-in. You might have signed up for a housing insurance (Home Protection Scheme) and life insurance (Dependent Protection Scheme) without your knowledge as these are mostly automatic opted-in schemes. This can help you save up on insurance premiums by not double or over insuring.


While it is highly impossible to insure or protect your entire asset or replace your full income due to its costs, it is important to use insurance to limit the losses or drastic change in lifestyle, should an event happen. This can be illustrated using the chart below.

A typical individual’s asset and income level throughout his life can be as stipulated below, where it increases to a peak, before declining down. This peak is happens during the peak of your career, which then steadily decreases. Using this curve, we can use it to better understand the level of insurance needed and the benefits of insurance.



The green and red line denotes the level of protection at different stages of life. When one just started his/her career, he might want to just have minimum protection just to replace his current income level, should anything happen to him. As he slowly progresses further, his income or asset level increase, followed by his commitments as he starts a family. This then translate to a higher level of protection needed as the amount needed to be secured is higher. As his commitments decrease, the amount he needs to insure decreases as well.

Due to costs, it is highly impossible and not recommended to insure entirely based on the blue line depicted in the graph, although this is the perfect scenario where most people would hope to achieve. It is a similar concept as the stop loss. Hence, the above framework to provide a better understanding of how insurance can be used effectively.


3.     What type of Insurance should you buy?
              
Before doing any insurance purchasing, it is always best to understand what type of insurance is available in the market and what are the pros and cons. There are 4 main type of life insurance from cheapest to most expensive:

                                                                     I.            Term Life
                                                                   II.            Whole Life
                                                                 III.            Endowment
                                                                IV.            Investment Linked Protection


Term
Whole Life
Endowment
Investment-linked policies (ILP)
Temporary protection which up to a certain age
Whole life protection
Temporary policy up to a certain age
Duration as specified by customer
Pure insurance tool
Insurance + cash benefit function
Primarily used for disciplined savings + investment function
Investment + protection function
-
Invests in the funds managed by the insurance company
Invests in funds managed by the insurance company or external unit trusts
Invests in external unit trusts

  
3a) Type of Life Insurance

I.               Term Life Insurance

This is an insurance that covers you for a specific period as stipulated by you – eg; 5 years or 30 years. It is the cheapest and most specialised form of life insurance. It protects the desired risk (death) and nothing else. If used intelligently, it can be the best and most cost effective form of insurance. 


II.             Whole Life Insurance

This is an insurance that covers you for your entire life PLUS a savings feature that provide you a sum of money if you decide to cancel your policy during the coverage period. The premiums paid are split in a fixed percentage throughout the whole period into insurance and investment.

The savings is accumulated by the insurance company investing a portion of your insurance premiums into funds managed by the insurance company. The insurance agent also draws a higher commission from selling such insurance contracts, so less of your premiums are actually paid for protection or for savings.
              
               Illustration:
                            




III.           Endowment Insurance

Endowment policies are designed to pay out the benefits when the insured person dies within the insured period or when the maturity of the policy is reached. This is like a term-life insurance contract with a savings function embedded. While the returns from such policies are not high, they can be used to enforce discipline to save.

* You could purchase term-life insurance and use the difference in premiums between term-life and endowment policies to invest for higher returns or put it in a Fixed Deposit, where you most likely will not be able to touch the money and can get a better return.


IV.          Investment-Linked Policies (ILP)

This policy is similar to whole life insurance policy; however the difference is in the amount of your premium going towards your life insurance and the savings/investment portion. While whole life insurance’s premium is split into insurance and investments in fixed proportion throughout the whole period; ILP usually put more of your premiums into the investment side when you are young, gradually shifting more towards the life insurance side as you age. Although most people buy into such insurance policy to achieve investment and insurance coverage, they end up being inadequately covered for both.

The reason for this shifting from investment to protection as you age is because you need more protection coverage as you grow old. The less money you have in your investment, the less you can draw out when you wish to, which is not necessarily a good thing when you are in your retirement stage. Beyond that, the returns generated by such polices are usually pretty low, ranged between 3%-5%. 



Illustration:

$1 of Premiums paid






3b) What insurance should you buy?
              
This really depends on your individual needs and requirements. If you would like to have purely an insurance protection, term-life would be more worthwhile. However, if you like to have insurance linked with investments or savings, then the other 3 insurance policies are also worth considering.



4.     Who should you buy your Insurance from?

When we did a research on insurance agents’ commission, we found that each agent will earn approximately 40%-70% commission from the first premium paid by their new clients. They will continue to draw commission from the premiums in subsequent years but in smaller proportions.
      
While it may seem that we are paying a lot to insurance agents, they actually provide great help when it comes to handling your claims when required. From personal experience, we know that it is difficult for individuals to handle the paperwork required to make claims.

It is recommended that you approach agents whom you are comfortable with and whom you know which insurance company they have links with as it is possible for agents to have linkages with up to 3 companies.

There is a method you could employ, which is to purchase a DPI from a provider and should you need to claim from the insurance company, the service personnel would assist on the matter. This is not only cost effective but also achieves the purpose of insurance. However, do note that this is still relatively new concept.

If you would like to find out more information, do visit and drop us a comment at http://investmentstab.blogspot.sg/



Summary of the general characteristics of each type of insurance
  
Term Insurance
Advantages
Disadvantages
  • Pure insurance

  • No sum assured

  • Low commission, hence lower premiums

     

Whole Life Insurance
Advantages
Disadvantages
  • Insurance as well as cash benefits upon surrender

  • Higher premiums due to dual functionality

  • Cash benefits are accumulated based on the returns invested in the funds managed by the insurance company

  • Higher agent commissions


Endowment Plan
Advantages
Disadvantages
  •  Insurance as well as cash benefits upon surrender

  • Temporary insurance protection

  • Cash benefits are accumulated based on the returns invested in the funds managed by the insurance company / external unit trusts

  • Limited insurance protection

  • Used to ensure discipline for savings



Investment-linked policies
Advantages
Disadvantages
  • Insurance protection duration may be specified by customer

  • Limited insurance protection

  • Investment and protection function

  • Temporary insurance protection

  • Invests in external unit trusts





References

www.diyinsurance.com.sg
http://www.investopedia.com/articles/pf/06/insureneeds.asp
http://www.forbes.com/sites/lawrencelight/2013/04/29/how-much-life-insurance-do-i-need/

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