Insurance & Costs of having and raising a child

[Bibi]

I personally don't believe much in insurance probably because I don't have much wealth, and I believe that my wife is capable to raise the kid and pay off the loans without my contribution. Having said this, I do have the very basic kind of insurances, namely the HPS, DPS and Medishield.

I thought if a person do not have much wealth he should buy more insurance (protection and medical)? If a person have immense wealth he does not need any insurance at all.

I am capable of supporting my family even without my wife contribution but that does not mean I need only basic insurance because how sure am I that I wont pass away from any dread disease in the next few years?

If I were to depend on only HPS, DPS and Medishield, I think I have to have enough wealth to ensure my dependents (kids and parents) can survive without me and taking into account my wife is not around too.

Well you may be right, but generally poor people tends to skip or buy lesser insurance because they don't afford to spend this kind of money. Only the middle income people contribute more to insurance company, i could be considered in between of poor to average people in terms of wealth, but i would rather prefer to have a poor people mindset so that i could save up more for early retirement. You may think that i am speculating on my health/life, but i actually i see health/life much more important than money, buying insurance doesn't guarantee one from falling sick or losing his/her life, so what for?

Buying insurance is to ensure the dependents still continue the life they could till they became financially independent. It is also to ensure the insured does not become a financial liability to the dependents in the event the insured did not die and his illness drag long and suffer huge financial loss due to medical cost.

You can see health more important than money but it is a fact we cannot control our life. A 29 year old can suffer a stroke (reported in recent news). A healthy person can die in his sleep. A regular runner can die of heart attack while exercising. Of course if die fast, things wont be so messy. But if faced with an accident and become brain dead, then how?

[Stephen]

this policy is more for her to "take over" when she comes of age; hence I view it as my daughter being able to hit 18 and beyond and then use the policy to cover herself when she starts work in case something happens to her (then HER family may need her income then and the policy can pay out a lump sum).

If indeed her future family needs her future income she would be better off with TERM insurance and not whole life insurance for the same reasons as you. With the whole life policy you bought, the coverage will not be meaningful unless you are paying an astronomical sum in premiums.

I was actually of the view that term life insurance, although it has a high coverage, is actually an expense and you cannot recover anything from it. Unless you expect to die or fall ill from major illnesses, there's nothing much which can trigger the "windfall" gain. Perhaps this thinking is flawed, but so far I have not come to the point of giving up my existing life policies and investing it all in term. Term insurance also steps up in 10-year age brackets, and becomes prohibitively expensive as one gets older. Alternatively, you can choose depreciating coverage with a fixed premium (similar to an amortizing loan), but the effects are still the same.

It is absolutely correct that term life insurance is an expense. Technically ALL insurance is an EXPENSE. Insurance is basically a bet you make with your insurer that you will trigger the policy (die/get cancer/etc) within the policy period. It is a bet you want to LOSE because if you "win" it means you actually lost i.e. you died, got cancer or whatever.

The fact of the matter is that when you pay the premium for a whole life policy, a portion of the money is paying for the actual life insurance. That portion is an expense and is lost forever. The balance is invested on your behalf. Over time the investment returns cover up the expenses paid for the life insurance, and you appear to be getting your money back. In other words, when you pay $1 for whole life insurance, maybe $0.05 is buying the life insurance (and is an expense, lost forever), and $0.95 is invested for you. Eventually the $0.95 grows to $1 and beyond, and presto! You think you are getting your money back.

Life insurers have chosen to confuse the issue by combining investment with insurance to create "life" policies because the consumers are misled into thinking they can "get their money back" and are thus more willing to buy the policy. Life policies are ENORMOUSLY profitable for insurers because on top of the premiums for the life insurance, they get money to manage, for which they charge management fees. And for non-participating policies, the insurers take all the profits in exchange for guaranteeing a low rate of return.

With normal unit trusts, you can redeem your money if the manager does badly, so the manager is under pressure to do well. With a life policy your money is captive - the insurer doesn't have to work as hard to invest properly because there is very little chance of the policy being canceled, since policyholders don't want to lose their insurance coverage.

Insurance gets more expensive as you get older because you are more likely to die from illness and less likely to recover from accidents. This is true for both term and whole life insurance, because fundamentally both incorporate the same insurance component. It's just that whole life policies hide the insurance component from view.

Purchased a Term Policy for myself which covers me for about $300,000. I do intend to increase this in future if my income level increases and I have more savings.

You should always buy insurance to cover your NEEDS. It has nothing to do with your INCOME. If you need $300k to bring up your daughter then buy $300k of term life insurance on your life. This is true whether you earn $50k or $200k a year. Don't buy term life insurance "for yourself" - because if you die the money gets paid to your ESTATE which can take months to settle. Buy term life on YOURSELF but with YOUR WIFE as the beneficiary. That way if you die your wife gets the money pronto.

Alternatively, you can choose depreciating coverage with a fixed premium (similar to an amortizing loan), but the effects are still the same.

It is more efficient to buy reducing term insurance, because if you die when your child is in her final year of university, there's only 1 year of expenses left and there's no need for the full $300k. If you are kiasu about inflation then add a 50% or 100% buffer. With declining term insurance the premiums are very cheap so you should be able to get double the coverage for the same money as normal term insurance.

Insurance is bought to offset an economic loss. Since you have only one dependent you only need to buy enough life insurance on yourself to see HER through graduation. Your mortgage should already have its own mortgage insurance so there's no need to worry about that. Your wife can work so you don't need to provide for her.

Take a hard look at the numbers and it will be obvious that investing the difference will leave you better off unless you are totally incompetent at investing AND do not have the discipline to invest in an index fund. If you are a competent investor you will easily beat the insurer. If you invest in an index fund you will probably still beat the insurer since your costs are lower. Since your daughter is only 2 years old you have over 15 years before you need the money. That is a great time horizon to be investing in stocks.

Hi peeps,

My baby is due dec so bringing up this old thread. I understand the rationale of BTIR and the concept of insuring economically active people who has dependents, therefore i have up-ed my insurance with term.

I initially did not want to insure my baby for death/TPD/CI as i thought its a waste of money as money saved can be invested and he has no dependents (Of cos i will insure him for H&S insurance as thats vital), till an agent told me that if he were to get a medical condition during the early years, say diabetes, he may not be able to be insured when he is economically active or otherwise insured with pre-existing conditions. This i agree, so just to reduce this risk, i planned to get one, and set my mind on a term insurance, thinking its cheaper and that i can invest the rest for my baby.

I was quoted for a sum assured of 100k Death/TPD/CI, accelerated benefits
Option 1-Term: $220 pa from 1 year old till 65 years old. Term coverage till 65 years old only.( total outlay till 65 is 65 x $220= $14300)
Option 2 - Pay 5 year Whole Life insurance: $1751 pa for 1st 5 years only. Thereafter, TPD till 70 years only and Death/CI will be till 99 years old.( total outlay is 5x $1751= $8755)

Even after calculations using time value of money, It seems to me pay 5 years whole life is vastly more superior as my baby( or rather his claimants) will definitely get back $100k as death is a certainty when its covered till 99 years.

Could i have an opinion on this as i may be missing out on something as i do feel whole life is better in this case?
Or are insurance companies increasing the premiums for term just to level the competition?( term is AXA term protector by the way)

(i have considered SAF aviva and NTUC LUV which are both group policies but it doesn't work for me as it covers till age 17 or 21 years as a dependent and therefore, he has to get his own SAF/LUV which he may not be able to if he had a medical condition before that. Worse is if he get diabetes, no payout that can be invested to cover his future need and yet precluded from future insurance)

[CY09]

Hi Stephen,

The calculation of time value of money depends a lot on the discount rate you have set. It seems the discount rate you have set is pretty low. I believe putting a discount rate of 6% will change everything. Secondly, how much does the whole return upon death?

[yeokiwi]

Even after calculations using time value of money, It seems to me pay 5 years whole life is vastly more superior as my baby( or rather his claimants) will definitely get back $100k as death is a certainty when its covered till 99 years.

You have decoupled BT and IR. BT and IR must work together in order to be more advantageous than whole life insurance.

Simple analysis.
Assuming that by buying term, you save $1751-$220 per year for five years.
Total amount save = (1751-220)*5 = $7655.

At the fifth year, you use $7655 to buy a 3% SGS bond. The annual interest rate is 0.03*7655 = $229.65.
So, you can happily use $220 to pay for the term and take $9.65 to buy yourself a good lunch annually.

I think the term life premium is on the high side and you probably can get a higher return for $7655 if you take on a slightly higher risk like buying SGX, SPH or whatever blue chips.

[Stephen]

Cy09- its a quote from a forum agent. Yes, need to check this return on death . 6 % discount rate yes, but this assuming CAGR investment of 6%... Not guaranteed will hit Such returns . best to compare with longterm bonds return as whole life has no volatility compared with equities. So its unfair to use returns of equities to compare

Alphaquant-highly dependent on discount rate

Yeokiwi- if I use 3%, saving $7655 first 5 years and saving $9.65 for 60 years till 65 years old will require about 75-80 years of not getting any death\ TPD\ CI for this term to be more worth it.. ( did not use a spreadsheet, simply a quick cal)I am not considering equities as I think volatility should be considered , whole life is a no volitility product thingy so have to consider like for like . bonds ok

Edited: I use Excel to calculate already. Savings of $1531 per year for first 5 years, thereafter savings of $9.65 per year if i chose Term and invest in a 3% SGS bond and assuming savings reinvested at 3%. It will hit $100,000 in year 87 to 88.
This means that if my baby pass away before 87/88, whole life is more worth it. But average male expectancy is 85 years, so isnt wholelife more worth it? But then again, this term might be overpriced

[NTL]

Hi Stephen,

Why more worth it when pass away before 87/88?

Without going thru calculations, what I see are the following scenarios:

1. From 1 to 40, without calculating time-money value, you pay less premium for insurance, so term should be more worth it, and also add back your bond investment.

2. From 40 to 65, your bond investment should be able to offset the premium paid during the period, so term should still be more worthwhile

3. From 66 onwards, if buy term, you left with the bond investment, which based on your calcuation, will hit $100k at age 87/88. So from 65 to 87/88, maybe wholelife will be more worthwhile. Thereafter, buying term will be more worthwhile.

So I guess whole life only give an advantage for the 20 odd years from 65 to 87/88?

Anyway, since you looking at buying term, why don't consider one that cover up to 99yr old? Then the coverage will be same as that of the whole life plan.

Disclosure: I had recently bought whole life plan for my 2yr old, but the plan includes early CI cover until he pass away. The plan does not stop at age 99.

[yeokiwi]

The insurance company is probably estimating an investment return of 4-5% on the paid premium and so, if you restrict the use of fund to only 3% bond yield, BTIR will not be able to match the insurance company return.

At 4% return, the paid premium will reach 100k at age 65.
At 5% return, the paid premium will reach 100k at age 53.

But as alphaquant had mentioned, 100k does not worth a lot after 65 years. Assuming 3% inflation, 100k in 2079 is equivalent to $14641 in 2014 . At age 85, it is worth only $8106.

[Stephen]

Hi Stephen,

Why more worth it when pass away before 87/88?

Without going thru calculations, what I see are the following scenarios:

1. From 1 to 40, without calculating time-money value, you pay less premium for insurance, so term should be more worth it, and also add back your bond investment.

2. From 40 to 65, your bond investment should be able to offset the premium paid during the period, so term should still be more worthwhile

3. From 66 onwards, if buy term, you left with the bond investment, which based on your calcuation, will hit $100k at age 87/88. So from 65 to 87/88, maybe wholelife will be more worthwhile. Thereafter, buying term will be more worthwhile.

So I guess whole life only give an advantage for the 20 odd years from 65 to 87/88?

Anyway, since you looking at buying term, why don't consider one that cover up to 99yr old? Then the coverage will be same as that of the whole life plan.

Disclosure: I had recently bought whole life plan for my 2yr old, but the plan includes early CI cover until he pass away. The plan does not stop at age 99.

NTL you are right about the different age bands. Could you share how much sum assured and premiums u paying?and possible the company too?

I chose 65 because after that baby should have retired and dependents are working

[Stephen]

The insurance company is probably estimating an investment return of 4-5% on the paid premium and so, if you restrict the use of fund to only 3% bond yield, BTIR will not be able to match the insurance company return.

At 4% return, the paid premium will reach 100k at age 65.
At 5% return, the paid premium will reach 100k at age 53.

But as alphaquant had mentioned, 100k does not worth a lot after 65 years. Assuming 3% inflation, 100k in 2079 is equivalent to $14641 in 2014 . At age 85, it is worth only $8106.

Hi Yeokiwi,

Thanks for the insight...you are right that it depends on whether I use 3,4,5 %..
But I'm just thinking the difference is really not that large and it's really subjective on which % to use.. So no clear cut winner.
I should really check the terms as its just a quote from an agent I spoke to at hardwarezone forum and it might just be a bait for me and the whole life might not be as what is mentioned

[CY09]

Hi Stephen,

Sense you are quite new to the field of personal finance; so let me provide some notes

1) 'whole life is a similar to bonds"
This is a definite no, while the payouts are smoothed out to reflect bond like payouts, the way whole life's funds are invested is not. A typical whole life fund invests in many components: 1) Bonds, 2) Stocks, 3) Buildings (getting rental from tenants), 4) Loans, 5) Cash. Commonly, the actual weight age of each component is approx 50%, 26%, 10%, 8% and 6% respectively. 2) and 3) are subject to market volatility and therefore 36% is subjected to "market volatility".

If there is volatility, why then are insurers able to pay bond like payouts, two reasons: a) they smooth out the returns and b) they publish very low "non guaranteed returns".

Generally the average returns of plain bond funds is 4-6% p.a. Furthermore, insurers do not just invest in sovereign bonds but in corporate bonds which offer higher returns (3 %to 7%) For simplistic sake of this post; let's set bond returns at 4.5% p.a. Stocks at 7.5% p.a , Building and loans at 6.0% p.a and cash at 1.2% p.a. These numbers are realistic and reflects with a high degree of accuracy the long term annual returns of each asset class. Therefore, the weighted return of this whole life fund is 5.35% p.a. However, it is ironic the non-guaranteed returns published in whole life insurance is 4.75% p.a.

2) The 3.25% or 4.75% Insurers publish are not the actual return figures you get
This is true, because in the first few years you get nothing. My calculations is that if insurers pay you the high end projections; the returns is only 4.2%. But so far only one insurer has been paying the top range of the projected. So therefore whole life insurance returns probably average 4% for policyholders (ironically its the same rate as CPF SA interest rate).

In addition, they mention it is not guaranteed, therefore they are not obligated to pay you the amount (even the 3.25% projection). Why? This is because market volatility may screw them up if a downturn lasts for 50 years despite their adequate buffer of approx 1.35% p.a.

3) Insurance money is locked up with insurers and you cannot use the money during financial duress unless you die. Should you decide to surrender your policy halfway, your returns could be halved to approximately 2.0 to 2.1%. While the method of "ir" grants you the flexibility.

4) Term only covers you till 65 while whole does till 99.
This is mainly due to the effects of compounding of the premium differentials between term and whole policies. The insurers have made enough money between giving you 4% returns and 5.35% to provide adequate coverage.

5) You mentioned the 1% p.a. returns is not much difference. In fact, it makes hell lots of difference as what yeokiwi has calculated. This is due to the magic of compounding. Open an Excel sheet and churn an initial sum of $5,000 at 4% returns and 5% returns over a 95 year period. You will be surprised at how large the difference is. Insurers know this and that is why the approx 1.35% per year they make over your lifespan from whole life/endowment/etc is billions of profits to them.

6) lastly, given all this info, I will like to say that your 3% discount rate is way too low and should be set at 4-5% because your time frame is long and CPF SA already offers you 4% returns and many good quality corporate bonds of long duration are above 4%. e.g. A recent 10 yr Stan Chart bonds was issued for 4.4%, Mapletree perpetual is at 5.125%