Chapter 4 : Life Insurance Policies

Transcription

1 Chapter 4 Life Insurance Policies Chapter Objectives Students must be able to: Understand the Different Types of Life Insurance Products Term Insurance Disability Insurance Critical Illness/Dread Diseases Insurance Whole Life Insurance Endowment Insurance Single Premium Insurance Investment-linked Insurance Malaysian Financial Planning Council (MFPC) 4-

2 Chapter 4 Life Insurance Policies Introduction Life insurance is a subject that many people are accustomed with and yet there are many who may not quite understand it. Let us take a look at the beginning of the concept of life insurance which dates back as early as 2,800 BC. Merchants, at that time, wanted to protect themselves against the loss of their possessions/properties. They realized that life was full of uncertainties and any misfortune could have a disastrous impact on life and property, and consequently affect the livelihood of the dependents. Life insurance is a powerful tool for creating an immediate estate. With a small premium the policyowner can create a large estate for the dependents. The first recorded life insurance contract was a term policy taken out by William Gybbon of London, England in This policy was for one year, commencing 18 June He died on 28 May the following year and the proceeds were given to his family. Types of Life Insurance Products Financial planners face competition not only from other financial planners, but also from brokers, financial institutions like banks, and mutual fund companies and as such, it is important for a financial planner to understand the different types of insurance plans that are available and how these can be packaged as a solution to meet client needs Term Insurance Term insurance provides temporary life insurance protection for a specified period of time called the policy term. There are two classes of term insurance, one provides cover against death only and the other against disability and death. The policy benefit is payable only if the insured dies or becomes totally and permanently disabled during the policy term and the policy must be in force at that point in time. The duration of the policy term varies from policy to policy. The policy period may be for 1, 5, 10, 15, 20 years or expiring at some specific age. If a term insurance policy covers an insured until age 70, it is also known as term to age 70. The policy coverage expires on the policy anniversary that falls closest to the insured person s 70 th birthday or upon reaching that age. The policy anniversary is the anniversary of the date on which the policy was issued. 4- Malaysian Financial Planning Council (MFPC)

3 Term insurance protection can be issued as a basic cover or as a rider attached to a life insurance policy. The benefit payable (sum assured) under a term life insurance whether as a basic or rider usually remains level throughout the term of the policy period. A rider is an attachment to an insurance policy that provides additional benefits payable over and above the basic policy. It legally forms part of a life insurance policy. Premiums payable are level during the term of cover. In some cases, premium for the entire term can be paid in a single payment at the policy inception ( also called a single premium payment policy). For a term policy no benefit will be payable in the event the insured survived the period of cover. Generally, term insurance is purchased because it is the simplest form of life insurance which provides the greatest insurance protection at the lowest initial premium (when compared to the other forms of insurance policies). For a term plan, as in all other types of life insurance cover, the younger the lives covered at standard rate, the lower the premiums charged. Basic term insurance is non-par, that is, it does not participate in the insurance company s profit and hence carries little or no cash values. Premiums for term insurance are determined at the point of purchase and will remain the same for the duration of the policy period. The premium will however change upon renewal ( if there is a renewal provision this will be discussed below) and usually a higher premium rate is payable due to older age Term insurance is useful in : providing a high insurance cover for individuals who could not afford the higher premiums of the other types of life insurance plans providing insurance for the duration of a financial loan or mortgage loan, providing insurance for covering investments, for example in a business during the buildup years protecting a business against the loss caused by the demise or disability of a key-man. it can also be purchased to cover a period of higher expenditure when the children are at college or university to ensure that their education will not be disrupted due to the untimely disability or demise of the breadwinner, can be used as a supplement to an existing policy to enhance protection coverage. can be used to create a large estate for distribution (legacy Due to market competitiveness and client needs, term insurance also offers options to include riders which: participate in the divisible surplus or profits of the life insurance company, provide disability benefits, Malaysian Financial Planning Council (MFPC) 4-

4 provide medical benefits, or cover critical illnesses. Some of the features of term insurance include option for reducing or increasing sum assured renewal, conversion, both renewal and conversion,. Renewable Term Insurance The renewal option enables the policy-owner of a renewable term insurance to renew the policy before expiry for the same policy duration. Generally, the renewable policy term may be for one-year, five years or even ten years. The sum insured may remain the same or at a lesser amount but not for a larger amount and/or for a longer term. The renewal premium rate is based on the insured person s attained age. At the older age, the mortality risk is higher resulting in a higher renewal premium (which will remain level during the new policy term before increasing again if the policy is subsequently renewed). Resistance to the higher premiums and the availability of other lower cost products in the market place may encourage those individuals who are healthy not to renew their policies. Thus those with poor health will renew even if the premiums are higher. However, this is already factored in the pricing structure of the product. To address this issue of moral hazard, most policies also contain restrictions on the insured person s rights to renew. Renewal option is normally not available after a certain age, for example, 60, 65 or 70. Renewals are also restricted to a maximum number of times, which will be specified in the policy contract ( say five times for a renewal term of 4 years each). The renewal option can be advantageous as the insured can continue the coverage by renewing the policy for a further term if circumstances do not permit for the conversion of the policy to other plans, for example when the policy owner is suffering from budget constraints, or from some medical condition. Convertible Term Insurance Term insurance that have a conversion feature allows the policy to be converted to a whole life or endowment insurance without any evidence of insurability provided that the sum assured to be converted is of the same amount or less. In other words, the insured is not required to undergo any medical examination or declaration of health. An example of this could be a situation where the insured person has suffered a deterioration of health rendering him uninsurable and yet the insurer is compelled to accept his request for conversion to a permanent policy. This conversion feature enables the insured to obtain the insurance cover at a lower premium initially and opt for a permanent cover at a later date when he is able to afford it due to a higher income level. Any increase in insurable risk at the time of conversion cannot be a basis for the insurer to increase the premium to be paid. Any increase can only be based on the new age at 4-4 Malaysian Financial Planning Council (MFPC)

5 the time of conversion. Like the renewal option policies, the conversion privilege policies carry a comparatively higher premium than a pure term policy. Some term insurance may offer a convertible plan for terms from 10 years to 30 years, or up to the age of 55, 60, 65 or 70 for the same amount and reduced amount of protection. Generally the conversion is only allowed within a certain stipulated period after the inception of the policy, or allowed up to a certain age, after which conversion is not possible. The privilege of convertibility is also to the advantage of the insurance company in that retention of policy is high with low acquisitions during the renewed policy term. Decreasing Term Insurance A pure term insurance policy is generally issued at a fixed sum insured that remains unchanged during the policy term. Decreasing term policies are policies where the sum assured reduces in certain amounts every year according to what is specified in the policy. These polices are excellent options in providing coverage for loans, for example housing loans where the principal amount decreases from year to year. The premium for such policies is fixed at the onset and remains the same throughout the policy duration. Single payment is also common where premiums are paid at the inception of the policy period. Increasing Term Insurance Increasing term insurance provides a death benefit that starts at one sum insured and increases by some specified amount or percentage at stated intervals over the policy term. The increase in sum assured will be done at the policy anniversary. The increase could be 3%, 5% or 10% of the beginning face amount or the face amount at the anniversary date depending on the policy contract. The premium for this type of policy also increases correspondingly with the coverage. The option not to increase the sum insured rests with the policy owner. Whole Life Insurance It is designed to provide a permanent form of insurance coverage on the life of the insured as long as the yearly premiums are paid. The premium amount is fixed at the onset of the policy and remains the same or level during the life-time of the policy. Insurers use the level premium system to price life insurance products so that the premium rate does not increase as the insured s mortality rate increases due to older age. The payment of level premiums throughout the life of the insured enables the insurer to create a reserve fund from the excess premium collected. These are invested and accumulated in the insurance company in the form of policy reserves and used to fund part of the future premium. The Asset Share Guidelines by Bank Negara Malaysia allows for a share of the accumulated premiums plus the investment earnings to be returned to the policy owner. It thus provides for Malaysian Financial Planning Council (MFPC) 4-

6 a possible cash value in the early years of the policy (even the first policy year) as long as, the accumulated premiums plus the investment earnings less the deductions for the cost of providing coverage, acquisition costs and other expenses incurred by the insurer, show a surplus (see the Appendix II at the end of the chapter for some frequently asked questions on the Asset Share Guidelines). Policy cash values are payable less any policy loans upon death of the insured. During the lifetime of the insured, the policy with cash values can be surrendered for an amount equivalent to its cash surrender value, if a need arises. If this happens, the protection also ceases and the policy comes to an end. Sometimes a part of the cash value can be taken out as a policy loan, if there is a need for some emergency funds. Such a loan will attract interest and the interest rate will be determined by the insurer at that particular time. The proceeds of a whole plan are payable when premature death occurs or the policy maturity date is reached. The policy maturity of a whole life plan is stated in the policy contract or at age 100 whichever comes first. Purchasing a whole life policy at a young age allows an insured to enjoy lower premium besides securing an adequate life cover. Premiums are usually payable throughout the lifetime of the insured up to e.g. 100 or at death whichever is earlier but most policies these days waive the payment of premiums upon the insured reaching a stipulated age e.g. 85. The cash value normally does not exceed the sum insured until the insured person reaches the age of 85 or 100. At that point even if the insured is alive the face amount of the policy is usually paid. The quantum of the cash value will depend on the face amount of the policy, the number of years the policy has been in force and the duration of premium payment. The presence of cash values allow the policy to be used as collateral for a financial loan or obtaining a policy loan from the insurance company at nominal interest rate. If the life insurance policy is used as collateral for a financial loan from e.g. a bank or finance company, it is normal for the lender to ask that the policy be assigned to the lender. In this instance, the insured will surrender all legal rights to the policy to the assignee (lender) and the assignee will recover the full amount of the loan plus interest from the contract in the event of death or disability of the insured, the borrower. The balance of the proceeds, if any, will be paid to the designated nominee or next-of-kin. A modern day variation of early whole life policy is one that allows for limited payment where premiums are payable only for a limited number of years and this is determined (projected) at the inception of a policy. This limited number of years for which premiums are payable is also known as critical years. It is also possible for a whole life policy to be paid-up automatically when the insured reaches an older age e.g. 65 or later. With effect from April 2001, all insurance companies have been instructed to treat premiums as payable for the duration of the policy and refrain from using critical years in their sales illustrations. Whole life policies can be issued as par or non-par polices - with or without profit participation in the divisible surplus of the insurance company. Returns to the par policy-owners is in the form of dividend payments, and these result from savings from mortality, expenses and from investment returns. The premium for participating policies is usually higher than non-participating policies. In spite of this, participating policies are gaining popularity. Participating policies usually carry higher cash values. 4- Malaysian Financial Planning Council (MFPC)

7 Premiums for a whole life plan are payable on yearly, half-yearly, quarterly or monthly basis. With the passing of time and market innovation, insurers have added on other riders to make permanent whole life insurance policies more attractive to consumers. Some variations of permanent life policies are ordinary whole life, limited payment whole life, whole life endowment, universal life, variable life, adjusted life, variable universal life insurance. Let s take a look at each of these in turn. Continuous Premium Whole Life The premiums for this type of policy will continue to be paid by the policy owner or the insured as long as the insured is alive. We use the term ordinary whole life in Malaysia to describe this type of policy. Sometimes it is also known as continuous premium whole life. The amount of annual premium will be lower than the amount of the annual premium for a limited payment whole life policy with the same face amount of coverage. Therefore, the continuous premium whole life policy offers the greatest amount of whole life insurance protection for the lowest annual premium. Because of this, many policyowners may prefer the continuous premium whole life policies especially profit participating basis. Limited Payment Whole Life Unlike the continuous premium payments of whole life plans, a limited payment whole life requires premiums to be paid for a specified period only, for example 10 years, 20 years, or until age 55, or 60 or 65. The aim of the limited payment policy is to ensure that no undue burden is placed on the policy-owner in the later years when the policy-owner reaches retirement and may find it difficult to continue with premium payments. Since fewer premium payments are expected to be made under a limited payment whole life, each premium payment will be larger than under a continuous premium whole life policy. The sum insured remains and will not be reduced, even though the premium payment years (period) have been shortened. Whole Life Endowment Policy This is a modified life policy that provides cash to be withdrawn at regular intervals for example, every 3 years or 5 years. This policy is also known as anticipated endowment policy. Premiums are payable throughout life and are higher than the premiums for an ordinary whole life policy. This type of policy is not very suitable for people requiring a high protection. Universal Life Insurance This type of insurance was first introduced in America by Hutton Life. Universal life is sometimes described as a flexible premium type of life insurance policy. This differs from the traditional whole life policy in the sense that after making the an initial minimum premium payment, policyowners may thereafter pay whatever amounts and at whatever times they wish, or even skip premium payments, provided the cash value will cover the policy charges. Furthermore, policy- Malaysian Financial Planning Council (MFPC) 4-

8 owners were allowed to increase (subject to evidence of insurability) or lower the death benefits of the policy as they deem necessary. Another feature is that the interest credited to the cash value is at the market rate, although it is normal for a minimum interest rate to be fixed. Some insurance companies may set a minimum protection e.g. at RM100,000 but the practice will differ from company to company. The insured or policy owner can withdraw the cash values without terminating the policy. Universal life policies deal with death benefits in two ways (options). The first option operates like the ordinary life policies (traditional whole life policies) and provides a constant or level death benefit. The second option provides a death benefit, which is equal to the original sum insured (face amount) and the accumulated cash values, at the time of death of the insured. Some people feel that this type of policy is the only type a person needs in his entire life because the above flexibilities allow the policy-owner to make the necessary or desired adjustments to plan depending on the circumstances.. Variable Life It is also called unit linked life insurance in many markets. It is a type of whole life plan whose values may vary directly with a set of pre-determined investment portfolio. It was introduced to help offset the adverse effects of inflation on life insurance policy values. It main aim is to have returns that are higher than the inflation rate, thus providing a hedge against inflation. The total risk of the investments will be borne by the policy owner. In Malaysia, this type of life insurance is the investment-linked life insurance plan and will be discussed later in this chapter. Adjusted Life Insurance This type of policy was designed to meet the changing needs of the policy owner and his ability to pay for the protection. It may commence as a life policy but it could be changed to a term policy, depending on the coverage required and the ability to pay the relevant premiums when the insurance needs change. The policy owner can choose to increase or decrease the premium and adjustments in the policy can be made accordingly. Variable Universal Life This type of life insurance is a combination of the universal life insurance plus the variable life. It thus combines the flexibility of universal life with the investment flexibility of variable life. This policy is also sometimes called flexible-premium variable life. The policy-owner decides, within the stipulations of the contract, the premium to be paid during each period. The policy-owner also has the option of increasing or decreasing the policy death benefit at will, subject to policy minimums, and with respect to death benefit increases, the insured will be required to provide evidence of insurability. 4- Malaysian Financial Planning Council (MFPC)

9 Home Service Insurance To conclude this section on life policies, mention must be made of a unique type of life insurance that is known as Home Service insurance. This category of insurance caters for people with very low disposable income. They would also require premiums to be collected at their homes or work places either on a daily or weekly basis by company representatives. Nowadays it can be done on a monthly basis. Usually the premiums are very low and the protection is also very low. The protection amounts can be as low as RM1,000 to RM5,000. Another name for Home Service Insurance is Industrial Life Insurance. This method of distribution is expensive and the cost of the protection is also expensive when compared to ordinary life policies and it is neither very popular nor cost-effective for both company and clients. Endowment Insurance Pure endowment is a plan where the sum insured is payable only upon maturity. In the event premature death occurs during the policy period, generally, all premiums paid will be returned to the next-of-kin, at a nominal interest rate. Because there is no protection element in a pure endowment plan, there is generally no requirement to undergo medical examination. This type of endowment is purchased for savings such as for retirement. Endowment insurance on the other hand combines elements of protection and savings. The sum insured is payable at the end of a fixed term, attained age or upon premature death. It is a combination of term insurance, which pays the sum insured upon premature death, and pure endowment, which pays the sum insured only upon surviving the agreed duration of cover. Like permanent whole life insurance, the premiums are level throughout the term of the policy. Cash values and reserves are similarly present. The rate of build up is much faster over a shorter period of time when compared to permanent whole life insurance. Some endowment policies come with a guaranteed cash payment every 3 years or 5 years during the term of the policy. This cash payment can be withdrawn or it can be kept with the company to accumulate with interest to be paid out at the maturity of the endowment policy. This type of endowment policies will attract higher premiums but some clients prefer this as every few years there is a guaranteed sum of money for them to use in whatever way they desire. The endowment policy can be used for basic income protection, provision of funds for retirement, children s education fund, or even a business startup fund, or a holiday like a cruise around the world on retirement. Malaysian Financial Planning Council (MFPC) 4-

10 Single Premium Insurance The traditional life insurance plan requires an insured to pay premiums annually in advance. Options for other modes of payment such as monthly, quarterly or semi-annually are allowed with the interest factor built in. This will result in slightly more premiums to be paid by the insured. Single premium payment feature allows an insured to pay a lump sum premium payment for the entire duration of the cover at the inception of the policy period. The amount to be paid will be actuarially determined taking into consideration the risk, investment, age and duration of cover. To the insured, it is a fully paid insurance cover for the duration of the plan and he need not worry about the payment of subsequent premiums. The lump sum payment of premium can be very large in amount due to the compressing effect of total premium payable. However, comparative savings can be a motivating factor due to the advance premium concept and discounting effect. Investment-Linked Insurance The first investment-linked life insurance contract in England was introduced by the London & Manchester Assurance Company Limited in It was known as a Unit-linked product. This was an annuity fund to provide for retirement for individuals who were self-employed. The early development of investment related insurance in the U.K was mostly dependent on the investment returns of a portfolio of ordinary shares. Similar to unit trust, these unit linked plans were mainly investment contracts for purchasing units in a unit trust fund.. In the United States of America, investment-linked life insurance is known as variable life insurance. It was pioneered by the Equitable Life Assurance Society and was offered for sale in In Singapore, investment-linked life insurance first made its appearance in 1973 and was introduced by NTUC Income. It was further promoted by the Central Provident Fund (CPF). When it merged its Enhanced Investment Scheme with the Basic Investment Scheme, to create the Investment Scheme in 1997, thus allowing more CPF members to participate in investment linked funds. In Malaysia, investment-linked life insurance was first sold by Syarikat Takaful Malaysia Berhad in a simplified form in In the last couple of years many other life insurance companies have followed suit as the companies recognize that there is a great potential for the product in the local market. Under section 7 of the Insurance Act 1996, insurers are prohibited from carrying on with investmentlinked insurance business except with the approval of Bank Negara Malaysia (BNM). This section carries out a penalty of three years imprisonment or a fine of RM3 million or both with default penalty Malaysian Financial Planning Council (MFPC)

11 Investment Linked Plans The Concept Investment-linked insurance offers investors an opportunity to purchase a life insurance policy that: provides an opportunity to accumulate wealth through participation in investment funds, and obtain some protection (death coverage) at the same time. The premiums paid to the insurer for the investment linked plan are split into two portions one portion is used to fund the protection that the policy-owner desires, and the other portion is invested for the policy-owners to get returns. The policy-owner undertakes to pay either a single premium or periodic premiums for the investment linked plan. The investment funds may be managed either by the insurer or may be managed externally by fund managers. The prime aim of investment linked policies is to provide protection and also enable the policy-owner to participate in investment funds to accumulate wealth. There are several key features of investment linked plans that must be understood by the financial planner. (i) Pricing and the Units The investment portion of the premium is used to buy unit in an investment fund. The units are purchased at the offer price of the units. Thus the number of units owned by the policy-owner is equal to the premium allocated to the investments divided by the offer price of the unit. The price of these units will depend on the total value of the investments in the fund divided by the total number of units in the fund. The value of these units will vary will the value of the total fund and are dependent on the investment performance of the fund and the market forces that affect investment returns ( these forces can be economic in nature, political etc). The price may depreciate, if the fund is not performing well, for example under poor economic conditions. On the other hand the price may increase (and the policy-owner reaps the capital gains and returns) when the price increases in a booming economy. As the value of an investmentlinked life insurance policy depends on the performance of the financial instruments, the policyowners bear the risks associated with the policy and enjoy the potential benefits of the policy. As far as the pricing is concerned, there are two methods of pricing the units in an investment linked plan: (a) The single-pricing method: Under this method, offer price and selling price is the same. The offer price is the price at which the units are offered to the policy owner, while the selling price is the price at which the units are bought by the company or cashed by the policy owner. (b). The dual pricing method: Under this method, the purchase price (offer price) is different from the sale price (also called the bid price). The difference between the offer price and Malaysian Financial Planning Council (MFPC) 4-11

12 the bid price is called the bid-offer spread, and this is generally about 5% of the offer price. (ii) Investment funds The insurer may have two or more funds available to the policy-owner. These funds are made known to the policy-owner upfront and the policy-owner has the option of choosing which fund they wish to participate in. For example, if the insurer offers two funds, a balanced fund and an income fund, the policy-owner (depending on the risk appetite) will choose one of two funds for the purchase of the investment units. Generally, the investment funds are as follows: - Cash funds (Bank deposits, fixed deposits) - Equity funds (Stocks, shares, etc.) - Bond Funds (Government and corporate bonds) - Property funds (Real estates, property shares) - Specialized Funds (segmented based on geographical regions or industries) - Diversified funds (variety of assets or fixed proportion of specified assets) Investment linked policies can be a very effective saving and investment scheme - based on the concept of dollar cost averaging. This simply means that through consistent and continuous purchase of units, the investor will shield himself from the volatility of the market, as some units may be bought at a higher price ( when performance is good) and some may be purchased at lower cost ( when the market performance is poor) thus averaging out the cost of the policy owner investment. (iii) Switching The flexibility of the investment linked plan lies in the provision that allows for the switching of the units from one fund to another. The policy-owner may at anytime shift the units from one fund to another depending on the performance of the respective funds. Generally, the insurer does not charge a fee for the initial switch, but may levy a fee on later switches. The number of free switches and the corresponding charge for the subsequent switch is stated in the policy contract. At times, the company may levy a charge on each and every switch. It is best to refer to the policy document for the details. (iv) Top- up Premium Another key feature in an investment linked plan is the freedom to top up the premium for the investment portion that is to make a payment to purchase additional units at anytime. Thus the policy-owner may from time to time purchase more units in the investment fund. This will 4-12 Malaysian Financial Planning Council (MFPC)

13 help to take advantage of the opportunity in the market place ( when prices are low) and build up a larger investment value over time. (v) Full or Partial Withdrawal The policy-owner has the option of withdrawing all or a portion of the units in the fund that is cashing out the units if there is a need to do so. A full withdrawal will lead to the liquidation of all units. The liquidation value is based on the unit price at the time of liquidation (for the single pricing method) and the bid price (for the dual pricing method). If a full withdrawal (surrender) is made the policy will cease to exist. A partial withdrawal can be made at anytime as long as there are a certain minimum number of units left in the fund to meet the company charges and the mortality risk charge. There is also a certain minimum amount that can be withdrawn at each request for a withdrawal. The minimum amounts are stated at the onset of the policy. A charge is usually levied for the partial withdrawals and the charge is also stated in the policy document. Generally, the withdrawal amount (or cash amount) can be calculated as follows: a. For the Single Pricing Method Withdrawal = no. of units withdrawn x unit price b. For the Dual Pricing Method Withdrawal = no. of units x bid price (vi) Premium Holiday A premium holiday is a feature that allows the policy-owner to waive the payment of the premium for a period of time. The premium holiday can be taken as long as there are sufficient units to cover the charges under the policy. The policy will still continue in force during the premium holiday. However, the policy owner is not advised to take a premium holiday for a long period as the number of units will continuously decrease over the period ( due to the cashing out) and the policy will ultimately lapse if there are insufficient units to meet the policy charges. (vii) Death and Maturity Benefits As for the death benefit there are two types depending on the company s policy plan:- Unit Value PLUS Sum Assured. The death benefit for the single and dual pricing method is given below: Malaysian Financial Planning Council (MFPC) 4-13

14 a. For single pricing method, the death benefit is equal to the number of units multiplied by the unit price and the sum assured is added to this value. b. For the dual pricing method, the death benefit is equal to the number of units multiplied by the bid price and the sum assured is added to this value. Unit Value or Death Cover The death benefit is the equal to the unit value or death cover, whichever is the higher. In the event that the policy holder survives the term, the total units purchased and any other units subsequently purchased via the declared income to policy owners. The death benefit is paid less any other administration or tax obligations upon maturity. (viii) Charges The charges of an investment linked policy could include the following: Policy fee it is same as for traditional life insurance policies. Annual fund management fee a fee of 0.5% to 1.5% of the fund each year. Mortality charges this covers the mortality cost and is therefore dependent on the age. Surrender charges this is a charge deducted from the value of the units at surrender. It represents initial expenses which have already been incurred but not yet recovered Partial withdrawal charges this charge is incurred per withdrawal. There is a minimum amount for withdrawal (e.g. RM200) as well as a minimum fund balance after withdrawal (e.g. should not be less than RM 2,000). (ix) Types of Polices The following are some of the major investment-linked life insurance policies available in the overseas market: a. Single Premium Investment-linked Whole Life Plan Most common type is the single premium investment linked whole life insurance plan, where a one-off premium contribution is made. The policy provides certain units in the fund as well as a certain life cover. The amount of protection is usually a percentage (usually about 125%) of the premium paid, and is subject to a minimum amount of RM 5, in Malaysia Malaysian Financial Planning Council (MFPC)

15 In Malaysia, single premium policies must have a minimum premium of RM 3, This plan emphasizes long-term savings and investment. b. Regular Premium Investment-linked Whole Life Plan Under this plan, the premiums are paid at regular intervals, either monthly, quarterly or annually. Units in the investment fund are purchased as the premiums are received. This plan emphasizes investment and life protection. c. Investment-linked Individual Pension Plan The main purpose is to build a large fund through investments of the premium. At retirement the fund is used to purchase either a traditional annuity or an investment linked annuity. Conventionally, there is no life cover in such plans and premiums are returned upon death. Life cover can be provided by taking up a separate term insurance policy. d. Investment-linked Permanent Health Insurance Provides health coverage such as disability income Contains cash value (unlike traditional health products). Sometimes its 25% cheaper than traditional policies. e. Investment-linked Dread Disease Insurance This plan advances the whole of the face amount in the event of the diagnosis of a heart attack, stroke, coronary artery by pass, end stage renal failure or total permanent disablement. Although there are numerous variations and types of investment-linked life insurance policies available in the overseas market, the basic types currently being sold in Malaysia are limited to the single premium life insurance plans and the regular premium life insurance plans. The benefits and risks of investment linked plans are summarized below. Malaysian Financial Planning Council (MFPC) 4-15

16 BENEFITS RISKS Pooling or Diversification Risk in volatility of markets Flexibility Expertise of fund managers Access to Diversified Portfolio No Need for o Personal Administration Return rate risks Risk of capital loss Comparison : Traditional Plans vs. Investment-linked Insurance Plans We can differentiate traditional policies and investment linked plans based on the following criteria: The investment returns and risks Traditional life products like term and non-participating whole life policies and endowment policies will guarantee a fixed rate of return. The pay out from these policies will depend on the stipulations in the policy contract either at death or disability or maturity as the case may be. Investment-linked products, on the other hand, do not guarantee a fixed rate of return, except perhaps the sum insured, which, in most cases, will be minimal. The investment returns will fluctuate according to the investments managed by the insurer, which may do well or otherwise. The insured will have to bear all the risks. However, it is likely to yield much higher returns over a long period of time. The general rule is that the higher the risks, the greater the returns. Those who are not risk averse will take up the challenge and may in most cases reap the rewards but it could also be that the investment may result in a loss. The death benefit and returns will depend on the performance of the investment funds. The computation of premiums The premiums for traditional without-profit life insurance policies are fixed at the time of inception whereas the premiums for investment-linked life insurance policies are fixed for the first year but may vary from year to year after that. Very much depends on what the insured wants as he is at liberty to increase or decrease his investment or he can just choose not to do anything about it after his initial single premium payment Malaysian Financial Planning Council (MFPC)

17 The death benefits The death benefits are stated in the traditional without-profit life insurance policies at inception whereas the death benefits for investment-linked life insurance policies are dependent on the actual performance of the investments. Only the sum insured is guaranteed. Even the sum insured can be adjusted upwards and downwards in the case of investment linked plans as the insured also has the flexibility of increasing or reducing the protection during the policy duration. This is generally, not allowed in the case of traditional plans. The surrender value Term policies of less than 20 years duration do not have cash surrender values, or if they do, cash value will be very minimal. Under the whole life or endowment policies, cash surrender values are available after the policies have been in force for three years. If the insured wants to surrender his policy after the third year, he may do so but it is not to his advantage as the amount he gets back will not be equal to the premiums he has paid. Should he wish to buy another policy in the future, the premiums will be computed at his new age. For investmentlinked life insurance products, the insured does not need to surrender his policy. He can make withdrawals from his investments as long as there are adequate funds at that particular time. The policy value will vary according to the value of the underlying assets which are tied to the fund. Options for topping up In the traditional life insurance policies, the option for topping up is not available. Should the insured require more coverage, he will have to buy a new policy. However, in investmentlinked life insurance policies, he can do so and will not lose out in any way in terms of, for example, increased premiums due to older age. Premium holiday In investment linked plans, the policy-owner can take a premium holiday and still enjoy the coverage, whereas for the traditional plans, the policy will lapse (or go into an automatic premium loan mode provided there is sufficient cash value) if premiums are not paid within the grace period. Methods of Analyzing Life Insurance Policy Illustrations As a result of the varied needs of individuals, insurance companies have taken to packaging their insurance plans with features and riders to suit just about every individual s circumstances. From the standpoint of policy owners, the amount of dividends and/or cash values guaranteed for a policy is important consideration to determine total cost outlay versus the benefits. There are several ways of comparing the sales illustrations between different plans. Each plan has its own advantages and disadvantages. One way to compare the sales illustrations would be to calculate the average annual cost or average annual payment. For a fixed determined duration, total premiums payable is deducted for total dividends for the same duration before arriving at the average payment. To further examine Malaysian Financial Planning Council (MFPC) 4-17

18 the comparison effect, the element of cash values can be taken into account before averaging over the duration to arrive at the average cost per policy year. The lower the average figure, the better is the policy in terms of cost outlay. (a) Interest Adjusted Method In an interest-adjusted method, the interest element is imputed prior to averaging the total cost outlay with regard to the dividends and cash values. This is to give proper weight to the dividends and cash values according to how far in the future the various amounts are payable. This method takes into consideration the time value of money by applying an interest adjustment to the yearly premiums and dividends. One method of calculation may use only the premiums and dividends. The other method may take into consideration the policy cash values. The interest factor used is normally a conservative figure, for example, 5%. (b) Internal Rate of Return Under the Internal Rate of Return (IRR) method, the policy accumulated values and the investment outlay are used to determine the yield over an expected investment period. The higher the rate of return the greater the accumulation of values and therefore the policy is considered a better one. IRR is more commonly used and better understood by most prospective clients. This method should also be used with care since the amount of risk premium as represented within the total cost outlay can have an effect on the IRR. If the risk premium can be identified and excluded in the calculation, the resulting rate of return would of course be higher. Therefore, an accumulation of RM100,000 over 20 years from an initial premium outlay of RM50,000 would mean a rate of return of 3.5%. If the risk premium identified results in an adjusted premium outlay of RM30,000 after deducting that amount, then the rate of return is a better 6.2% for the same period. Policy sales illustration is fundamental to life insurance presentation. These are usually presented and sometimes explained to the prospect prior to the closing of an insurance sale. Financial planners will therefore have to know what is printed on the sales illustration to better appreciate the financial picture of the plan and they will be able to clarify doubts if the prospective client should have any. A typical sales illustration generally contains a brief description of the plan i.e. coverage, exclusions, sum insured, premium to be paid, bonus declaration and benefits. Depending on the type of plan, a participating policy may have both guaranteed and non-guaranteed values. Guaranteed values are normally stipulated as guaranteed in the sales illustration. Nonguaranteed values such as reversionary bonuses, maturity bonuses are similarly indicated Malaysian Financial Planning Council (MFPC)

19 APPENDIX 1: Key Features of Life Insurance Products 1. Participating vs. Non-Participating Life insurance plans can be issued on either a participating or non-participating basis. The decision to purchase a with profit participation life insurance policy (par policy) or a non-participating policy (non-par) varies from policyowner to policyowner. The profits or surplus are derived from a company s profitable operations - contribution to the surplus comes from lower claims, lower expenses, lower overheads and higher than projected rates of investment returns. The policy s share of the divisible surplus is distributed as dividends or bonus. A par policy on the other hand would have a higher return element than a non par policy. The premiums are of course much higher. A par policy which has been in force for 20 years or more has been found to pay out a final amount of about twice the original guaranteed sum insured. Insurance companies, therefore, have to ensure that they are able to price their participating plans appropriately and pay the projected dividends while remaining competitive in the market place. 2. Concepts of Bonus Bonuses are the part of the profits of the insurance company allotted to the participating policy holders. However, bonuses are projections based on the future - the projected or anticipated performance and operational efficiency of the company. They are therefore not guaranteed. Most life insurance companies however make good attempts to meet their projections and pay up according to the projected figures. Some of the types of bonus are simple reversionary bonus, compound reversionary bonus, cash bonus, guaranteed bonus, maturity bonus, interim bonus and terminal bonus. (i) Cash Bonus Cash bonus as the name implies involves actual cash payments and these can be taken by the policy-owner once they are declared. However, the policy owner may leave the amount with Malaysian Financial Planning Council (MFPC) 4-19

20 the insurer and earn a certain prescribed rate of interest. Cash bonus is equivalent to cash dividends in our local context in Malaysia. Another example of bonus payment would be a guaranteed cash bonus which is payable once every 3 years as long as the insured is alive and the policy is still in force. The amount can be equal to 5% of the face amount during the first 12 policy years and 10% from the 15 th policy year. In order to improve the cash value of the policy, it is advisable to retain these cash payments in the policy to take advantage of the compounding effects of interest. (ii) Reversionary Bonus Reversionary bonus on the other hand is not in the form of cash payment but as an add-on to the sum assured of the policy. The bonus can be simple or compounded. Reversionary bonus is usually declared at the end of the year. Most if not all insurance companies compounded form of the reversionary bonus - which means that bonuses paid in previous years will be compounded in the subsequent policy years. For example, a 20-year endowment policy of RM100,000 with a bonus of 3% will be entitled to RM100,000 x 3% = RM3,000 bonus at the end of year one. The sum insured is now RM103,000. The next year s bonus is calculated at RM103,000 x 3% = RM3,090 and the sum insured at the end of year two is now RM106,090. The reversionary bonus forms part of the sum insured and it can be surrendered leaving the original sum insured of RM100,000 intact. At the end of year ten, the total sum insured will be: RM100,000 (1.03)¹ = RM134, The bonus portion of RM34, can be surrendered if required. However it is best left in the policy to accumulate more returns. (iii) Performance Bonus It is, however, not unusual for insurance companies to provide policy holders a bonus on top of their usual ones when their investment and operational efficiencies have resulted in exceptional performance returns. A certain portion of the better than expected returns will be allotted to reward policyholders and shareholders. The balance will go towards company reserves. It is not mandatory that they have to pass this on to policyholders but many insurance companies would do it as an appreciation to policyholders. Sometimes, insurance companies may use this 4-20 Malaysian Financial Planning Council (MFPC)

21 as part of promoting publicity, because when this is done, policyholders will likely tell others about this and many may also buy similar policies from these companies. (iv) Terminal Bonus Terminal bonus is the extra bonus payable on life insurance policies which have been in force for a minimum number of years. Some companies may commence paying this terminal bonus at the end of 10 years or 20 years. Depending on policy conditions, terminal bonus can be paid on surrender after a stipulated minimum number of years, or when a claim is made upon death or at maturity. Terminal bonuses are determined by the insurer and are dependent on the operating performance of the insurance company. It is calculated as a percentage of the accumulated annual bonuses. Let us assume a terminal bonus of 25% is to be paid out for a RM100, year endowment policy at the end of year 20. The reversionary bonus declared till then is RM50,000. Terminal bonus would be RM50,000 x 25% = RM12,500 The total amount paid out would therefore be RM162,500 (v) Maturity Bonus Maturity bonuses are bonuses which are payable for policies that are kept in force until the maturity date by the policy owner. The maturity date is effective either at the end of the stated policy term or when the insured reaches a specified age. Therefore a maturity bonus of a certain amount e.g. 60% of vested bonuses would be paid upon the policy maturity date or upon the policy owner reaching the age of 65. These bonuses are normally determined by the insurer and are dependent on the operating performance of the company. 3. Policy Discontinuation: The Non-Forfeiture Options Non-forfeiture options are benefits available to life insurance policies, which have the effect of preventing the policy from lapsing in the event of non-payment of premium. Non-forfeiture options are triggered the moment a policy, which has attained cash values, is in danger of lapsing. Some of the options available to the policy owner are paid-up insurance, automatic premium loan or extended term insurance. (i) The Automatic Premium Loan In the event of non-payment of premiums after the grace period, the policy cash value is automatically used to pay for the outstanding premium. The amount so utilized is deemed a policy loan, which carries a nominal interest rate (automatic premium loan). This option can Malaysian Financial Planning Council (MFPC) 4-21