A good life insurance policy

I have often been asked, "is this a good life insurance policy?"

If this policy is being sold to you by an agent, you can be 90% sure that it is a bad policy. The agent (who can also have a title such as financial adviser or consultant) is likely to offer you a policy that requires you to pay a big monthly premium and gives you a poor yield. But the agent will sound impressive, as he or she has been specially trained in marketing and telling (exaggerating) the benefits of the policy.

Here is a simple test: if the policy provides pure protection (i.e against death or critical illness), ask the agent to get you a comparison of the premium rates charged by other insurance policies on similar policies. You should pay an annual premium of not more than $500. If the agent is not willing to provide this service, or does not give a fair or clear comparison of the comparable products, DO NOT TRUST THE AGENT!

If the life insurance policy is intended to give you a return on your savings, you should calculate the reduction in yield on the policy. This is the difference between the gross yield used in the projection (which could be 5%, 9%, 5.25% or 3.75%) and the net yield produced by the cash value. If the policy is for a long term, take the cash value at 25 years. If it is for a shorter term, take the cash value at that shorter duration.

You can calculate the net yield using an Excel spreadsheet of financial calculator, as explained in this FAQ. If the reduction in yield is more than 1.5%, YOU MUST REJECT THE POLICY!

You will find, in nearly all cases, the reduction in yield to be much higher. It is typical for the reduction in yield to be 3.5% to 5% per annum. This leaves you with a gain that can hardly keep up with inflation.

Here is an example of how the consumer is usually deprived of a decent yield:

• If a consumer saves $500 a month over 25 years, the accumulated premium should be $295,000
• If the reduction in yield is 1.5%, the cash value should be $237,000
• If the actual reduction is 4%, the cash value is $168,000

In the above example, your accumulated premium should be $295,000. By giving a cash value of l$168,000, the insurance company is taking away $127,000 from you over 25 years. This is too much to take away. A fair amount for the insurance company to take away (i.e .for the insurance cover and the investment service) is $58,000, leaving you with a cash value of $237,000. 

Do not buy a life insurance policy that pays you only $168,00 when the minimum that you should get is $237,000.

Tan Kin Lian