Insurance & Costs of having and raising a child

[kazukirai]

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.

This discussion is indeed turning out to be a very good one.

D.o.g.'s point is very true. I recently bought a term insurance on my life with critical illness , accident and TPD cover DESPITE my financial advisor repeatedly trying to get me to take on an ILP.

Why? That's because I ran the numbers through. I took the difference paid in premiums between the ILP and Term (for the amount, I was looking to cover, I think the difference was some $200+ per month), plugged in an arbitrary 5% returns and it still came up tops over the NON-Guaranteed benefits illustration provided by my financial advisor. Of course, when I showed my financial advisor the illustration I had, he gave all sorts of arguments like "Are you sure you can consistently get 5% p.a?" or "My firm, XX, has the financial clout to ensure that your returns are protected." but it's human nature to not understand something when your salary depends on not understanding it.

For those in a similar situation (where you have a so-called 'professional' advising you otherwise), it may be beneficial to go through the same exercise and you will feel much more empowered to make a clearer decision.

As Buffet said, "Never ask a barber if you need a haircut."

[Musicwhiz]

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.

Well, as mentioned, the policy is intended to have some surrender value should she need the money urgently. For term insurance, I do of course agree that the coverage is much higher but then again it's an expense and there will be no recoverable. In this respect, perhaps a combination of life + term is a better bet? I do take your suggestions to heart but then again we all have different personal circumstances and commitments.

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.

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.

Agreed, and this is what I learnt from you in one of your older posts. Insurance is basically a bet with the insurer on whether you will die young or old! I look at it as basically peace of mind and to give my family a somewhat comfortable life without me around (as they are the beneficiaries). Of course, as you say, I want to LOSE! Haha.

I also understand the part about the investment of life insurance, in that only a small component is used for protection while the majority is used for investment (at presumably lower rates of return than what a savvy investor can achieve). But as I said, I will treat this as an asset for my kid and at the same time, I am also planning to review my financial planning as early as Jan 2011, and may tweak the components you mentioned further.

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.

Yes, no worries I do understand this part; however, what I was trying to say is that with more disposable income, I will be able to set aside more savings for higher term insurance. Of course, the argument will probably be that one should set aside this amount for insurance anyway in light of personal circumstances; but I do see the need to set aside a suitable amount of savings for my opportunity fund too (which, as you may already know, I use for investing in equities). As for the beneficiary, thanks for the reminder, I will check with my planner on whether I had designated my wife as the beneficiary.

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.

Yes, I had a plan to buy reducing term insurance; but then something cropped up and I was forced to delay my purchase of this. I had already met up with my financial planner recently this year and agreed in principle to purchase the reducing term insurance as she had recommended, but thanks for the reminder. Now I know I need to expedite this in Jan 2011!

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.

Investing the difference only makes sense if you really know how to invest (I can't say for sure that I do!) and you have a long time horizon. Of course, beating 2-3% per annum probably is not so tough at all, but one has to work considerably hard and be diligent in order to ensure one's money gets an adequate return.

Thanks for all the great advice! I will look up my financial planner again about the reducing term insurance and disability income insurance, and at least with your inputs I can have a more meaningful discussion.

[mikh]

IMO, insurance is basically a safety net, and one needs to be careful not to confuse it as good investment. Going along with d.o.g., ksk's points, we can look at this from another angle.

According to me it is fair assumption that investment specialists should do better than insurers simply because the insurers' core competence is insurance and not investment per se. That said, we still need to pay the sales and management expenses for both the "insurance team" and the "investment manager". With the changing financial landscape in the last decade or so, the insurance people start to sell more investment products somewhat and try to morph themselves to also become investment specialists; but we can ask ourselves who is likely to get us better returns AFTER substraction of costs and fat salaries: insurers, investment specialists, Index funds, others or ourselves? We cannot conclude who is best, but i have an opinion on who may not be well suited. I don't count on the insurer for economic or investment gains; other than to have an interest in the insurer's shares

And YES, haha, I should think twice about asking the barber if i need a haircut!

[Bibi]

Hi Bibi,

Won't you take a massive loss if you choose to terminate your life policy?

I am currently paying for a full whole life policy with GE..
Flexilife 20.. My friends advise that once you take it up... May as well pay till maturity as premature termination results in hefty loss...

What do you think?

Hi Zelphon,
I had the 2 policies many years back and they have broken even (i.e surrender value > premium paid to date). Yes, by terminating early, i will lose out the coverage as well as future bonuses which usually gets larger as the policy is held longer.
I had bought enough term coverage taking into account that these 2 policies will be terminated. My opinion is, its not difficult to earn return of ~100% when you put in those money in shares during recession period. Usually once i used up my investible cash it will also mean we are in quite deep recession.

I think the only good thing about life policy is if one intends to pass on the death benefit money from the policy to his next generation. The death benefit really is quite an amount if one held it on for a long period of time. But then, its non-guaranteed .

I terminated a 7 year old AIA ILP policy for my wife and i incurred losses of 50%. Total premiums paid is ~8k and i lost ~4k. My opinion is short term pain is better than long term pain. AIA funds imo are the most underperforming as compared to other insurance companies' funds.

I wont advise a person to terminate unless that person is very confident of acheiving consistently good returns in excess of 6% annually.

For people who knows nothing about investments and not willing to learn, then life/endowment polcies will suit such people.

[d.o.g.]

the policy is intended to have some surrender value should she need the money urgently.

Make up your mind! Do you want her dependents to have protection, or do you want her to have an asset? If you want protection for her dependents, buy a term life policy on her life, payable to her estate. If you want her to have an asset, invest the money on her behalf. If you want both then split the money into 2 pots, one for term life and another to invest, either by you or in an index fund. The invested money will very likely be worth more due to lower costs. If it is invested better it will be worth much more. It will definitely be more liquid as you can liquidate partially or fully at any time, with no loss in insurance cover. If she will "need the money urgently" then investing the money separately is clearly the way to go!

With a whole life policy you get the worst of both worlds - low protection value and horrible returns, plus zero liquidity and no ability to switch investments if the insurer does terribly at investing.

NO WHOLE LIFE. NO NO NO. If you choose whole life then you must recognize that you are deliberately making an irrational and uneconomic choice for "peace of mind". But how do you expect to succeed elsewhere in life, ESPECIALLY IN INVESTING, if you deliberately behave irrationally and act against your own interest?

Yes, no worries I do understand this part; however, what I was trying to say is that with more disposable income, I will be able to set aside more savings for higher term insurance. Of course, the argument will probably be that one should set aside this amount for insurance anyway in light of personal circumstances; but I do see the need to set aside a suitable amount of savings for my opportunity fund too (which, as you may already know, I use for investing in equities).

The order of priority for money is:

1. Daily expenses (food, transport etc)
2. Insurance to cover unaffordable losses
3. Investment for future consumption i.e. retirement

Buying insufficient insurance coverage in order to have more money for investment exposes you to the risk that your insurance cover will be required before your investments have grown to sufficient size i.e. you die early, and your insurance proceeds plus investment assets together are not enough.

You should take care of your insurance requirements BEFORE you set aside money for investment. Insurance is more important than investment because while investment can make you rich, insurance can prevent you getting poor. Obviously, it is more important to avoid poverty than to acquire wealth.

I will look up my financial planner again

IMHO from what you have shared, you may want to consider changing financial planners because he/she is clearly not helping you to make good decisions. Speaking for myself, I think he/she has let you make at least one bad decision, this whole life policy.

You may want to try Wilfred Ling. I do not know him personally and have no professional involvement with him. But his blog is quite well written and shows he has given some thought to really trying to help his clients. He is fee-only, so on a dollar basis he will not be cheap, but his advice will not be biased by commissions.

I don't agree with Wilfred's stance on avoiding ALL actively managed funds in favour of index funds, but that is because I am biased since I am a fund manager. The statistics are in his favour - MOST actively managed funds don't beat their indexes - so his decision to favour low-cost index funds is correct.

[Musicwhiz]

Hi d.o.g.,

OK that was hard-hitting, but I think I got your point! So it's better if I terminate her whole-life policy and split it into part life + term? Or as you say buy term and I invest on her behalf? But if say I want her to have an asset which she can choose to liquidate when she is past 18, can I still buy a hybrid life/term policy? In that case, it makes sense to keep the life portion small and the term portion (protection) larger. I'm not too good with insurance so appreciate your advice here.

Your advice on the order of priority of expenses is also appreciated. I've always known that I had not set aside enough money for insurance coverage, and yes I do intend to change that. Which is why I want to pump in more money for my insurance to boost coverage through reducing term insurance for me and my wife. At the same time, I will liquidate some whole life policies which were purchased when I was much younger by my parents, to free up the cash for investments. I do agree that allocating more of my savings to insurance is more important than saving up for investments, but as of now I am also trying to create some buffer for emergency expenses for my whole family (as I said I have personal issues which require a larger buffer than most would see as "normal").

So perhaps my planner is not giving me the best advice, but then again I guess I did communicate that I wanted a life policy instead of a term one because of my lack of understanding of how it works, so she cannot be blamed too much for that.

I may contact Wilfred Ling to discuss my financial planning and retirement planning. Thanks for your advice.

[d.o.g.]

OK that was hard-hitting, but I think I got your point!

Sorry. On re-reading it does seem somewhat harsh. No offence meant.

But if say I want her to have an asset which she can choose to liquidate when she is past 18, can I still buy a hybrid life/term policy? I'm not too good with insurance so appreciate your advice here.

I am not a financial advisor so I cannot give advice. I can only say that in my personal view it is absolutely crucial to separate insurance and investment.

If you want her to have an asset then invest on her behalf. Earmark it in your own records. Then you can transfer the assets or their equivalent value to her name when she is 18, 21, 25 or whenever. If you want her to have insurance cover then buy a separate term policy on her life. But as I pointed out this is pointless since she has no dependents and no earning power. She can buy a term policy on her own when she gets married.

The life policy as I have emphasized will do you no good in this regard since the returns will be poor and the liquidity is zero, and terminating it also ends the insurance cover.

Do not buy ANY whole life policies. Agents love to sell them because the commissions are so high. But because the commissions are so high, they are terrible for consumers.

[Musicwhiz]

Thanks d.o.g., no offense taken.

I am reviewing my policies now (I have a summarized sheet) and realized that I had purchased quite a few whole life policies (some when I was young, and some in early 2000s), so I guess I made some bad mistakes there. I'd probably liquidate most of them and buy additional term to cover myself; then invest the money saved. Good idea when I started to think about it - I should have done this long ago haha.

As for my daughter's policy, it would seem that I should terminate the Whole Life policy to save myself money moving forward in 2011, and use the money saved to further increase my term coverage (for me and wife). Will have to speak to my planner about this. I guess although I already spent some $$ on my daughter's whole life policy, it's better to terminate now rather than suffer more years of paying when the returns are poor, and I can use term instead.

Once again, thanks!

[Bibi]

If you want her to have insurance cover then buy a separate term policy on her life. But as I pointed out this is pointless since she has no dependents and no earning power.

Hi d.o.g,
How about child critical illness or TPD coverage? Do you see that as important? Health plan usually allows post-hospitalization claim till 90 days. So for illness that drag few years or worst for life, it can be a drain to the parents financially.

[mikh]

I am reviewing my policies now (I have a summarized sheet) and realized that I had purchased quite a few whole life policies (some when I was young, and some in early 2000s), so I guess I made some bad mistakes there. I'd probably liquidate most of them and buy additional term to cover myself; then invest the money saved. Good idea when I started to think about it - I should have done this long ago haha.

MSW, I believe you are not the only one to have lost track of policies.
Off topic, but this discussion just reinforces my belief that Personal Insurance is a fat and profitable industry. I think only GE is listed for investment? Does anyone know others?