Financial product with a guaranteed return

Dear Mr. Tan,
What are your views about life insurance products that give a guaranteed return?

REPLY
Life insurance companies sell products that offer a guaranteed return. They may appear to be attractive to a risk adverse investor, but they generally give poor value to the consumer.

If interest rate goes up, due to inflation, the life insurance company makes a big profit. The consumer gets back the savings in depreciated dollars.

If insurance rate goes down, the life insurance company makes a loss. To avoid this loss, they get the insurance agent to convince the customer to switch to a new product (which usually contains some frills). The customer is not aware that the new product offers a poorer return. In addition, he has to suffer the upfront cost of the new product.

I have seen this unethical practice over the years, in several countries. Here is an example of the potential impact of a change of interest rate.

1. Take the case of a 30 year endowment policy with a guaranteed return of 4% per annum. An annual premium of $5,000 will produce a guaranteed maturity amount of $280,000.

2. If the actual interest rate earned by the fund over 30 years is 6% per annum, the premiums paid will accumulate to $395,000. The insurance company pays out the guaranteed amount of $280,000 and makes a profit of $115,000.

3. If the actual interest rate earned by the fund over 30 years is 2% per annum, the premiums will accumlate to $203,000. The insurance company should suffer a loss of $77,000. The insurance company can avoid this loss by getting the insurance agent to make the customer switch to a new product.

Lesson: If you are making regular savings in the future, it is better to invest in a transparent product, such as a low cost unit trust, and keep the return for yourself. Do not give the return away by buying a guaranted return.

If you have bought a guaranteed product, do not allow the agent or employee of the company to talk you into switching to a new product.