Since there's nothing much buzzing in the markets on the last Friday session before Christmas week, I wanted to talk a little about insurances and how they relate to young people, specifically in the context of my resident country Singapore. This post is not going to be sensationalized in any aspect, because I personally like to take topics as intricate as insurance as objectively as I practically can.
As a note, this insurance space on Business of Finance is in its infancy and much more useful material will be added in due time. As Business of Finance seeks to cater to a wider audience in its service of imparting knowledge, insurance is one of the more relatable and also more important aspects of financial planning on the micro level.
In my time as a licensed financial advisor (if you don't already know what this means, please search up this term and have a look at the relevant MAS rules), I have met my good share of people of all walks and ages of life. My portfolio of clients is messier than a badly arranged mosaic piece. Not that it's a bad thing, but the variety of lives that I advise on gives me substantial insight and experience to provide readers with a fair exposé of the picture I see in a daily basis. Ask 10 financial advisors and younger just get 10 different answers to the same question. There are of course entirely wrong opinions, but most opinions are just colored differently.
Something about financial advisors
Remember, the financial advisory industry is a service orientated one. Clients pay to be serviced, to be given advice, and to benefit materially. Readers should not forget that there is absolutely no wrong in being remunerated in the provision of such services. I say this because I feel, the insurance industry is collectively viewed upon by society through a yellowed and outdated lens.
In my experience of meeting strangers for new business, I have gathered that a good majority of Singaporeans hold a slightly to fairly skeptical view on financial advisors. Read that again, a good majority of Singaporeans are skeptical about the people that provide the services, and not the services themselves. The highly probable reason for this skeptical is the fact that financial advisors profit from providing the services, or selling insurance.
Is this view justified? No it isn't.
Seasoned advisors understand that this is part of the business, and it is also common understanding that a minority of Singaporeans have suffered some form of bad experience. Without going too deep into this particular rabbit hole, I wanted to express my disagreement with this form of thought. An entirely separate article will in due time, be dedicated to addressing this age-old enigma.
A good tangent to draw would be the services industry. Singaporeans are permanently dissatisfied with the service standards they receive. While consumers never mince their words in lambasting their servers, they almost always fail to recognize the awfulness of their conduct when interacting with their servers. Psychologists call this confirmation bias. Much more in another post.
Every industry faces their own set of ridiculous myths and frowns from the public. It might be just me, but as an individual that takes pride in his service, I have no reservations standing up to what I believe is wrong; especially if it directly affects the industry I'm in.
I meet youngsters every other day. Generation Y, or the Millennials as they're called, are strongly opinionated these days. These are the people that traditional and conservative political parties worldwide are afraid of. These are the people that threaten to burn down the house if their demands aren't met. These are the people who's voices are propagated loudly for all to here. Savvy, outgoing, and full of rave; the world calls them the planet shakers or the people that spark revolutions. There is ample evidence is modern history to support these fixtures placed on these special people: the Arab spring, the global Occupy Movement, various political uprisings and ousters of key political figures et al.
So full of energy they are that too oft than not, they do not see nor feel the need for insurance. Some of them speculate bravely in the stock market, making and loosing money; others opt for a "spend as they go" lifestyle where social trends are their next best friend. These are savvy people and no one with a few neurons really doubts that.
With everything on Earth, for every action there is an equal but opposite reaction. You can't have your cake and eat it. I'm not a sociologist or anything near that, but one can see from afar these particular group of people are more self centered, they lack a certain depth of maturity their forerunners had; these are the people that are more liable to charge forth towards their goals with all might and fury, but leave others in their wake.
They spend a good deal of their time seeking material gains, nothing wrong in that, but sometimes fail to understand the value of the intangibles. Being strongly opinionated, it is more difficult for them to accept the opinions of others prima facie. Such is their downfall, or their Archilles Heel, being focused towards the front, they miss many things that may come from their sides.
This is the fundamental reason why the Millennials are relatively less receptive to the idea behind insurance. They are naturally taught not to foresee or harp on the untoward events that will become an eventuality, although they live in a world where there is no dearth of such cases. Ironic? Hell yes it is ironic. Across the vast swathes of young people I meet, people who could potentially have been my clients, a large portion of them cite reasons such as financial commitments, disinterest, of being of the believe that getting insurances doesn't help optimize their their state of affairs.
Although I'm in no position to make judgements or pass remarks, I feel these particular group of energetic people are missing out. Not many advisors that I know of can condense the idea of insurance into two very distinct yet harmonious tones: the fragment of time, and the fragment of events. Most people can relate to the latter, but not the former.
The 3 most suitable insurances for Generation Y
Without much further ado, I'd like to talk briefly about what I think are the 3 most suitable types of insurance for this group of youthful people. This is by no means exhaustive, and only reflects my views. Again, by being in the business of providing sound financial advice, and having met a good deal of clients, I think I have basis in these opinions. Take them for that they are worth.
Whole Life Insurance
- Capitalize on young age, lock in lower premiums;
- Time is on your side, leverage on it;
- Guaranteed returns once bonuses declared;
- Gives you flexibility across protection, ordinary savings, and retirement savings
Whole life insurance is the most common yet most misunderstood form of insurance. It is one of the most powerful forms of financial innovations of the 21th century, in my humble opinion. Forget financial derivatives, or weapons of mass destruction as Warren Buffett likens them to. The main distinguishing element of a whole life insurance is it accumulates what is known as cash value, meaning it acquires value as the insurance is kept going.
The financial cost per dollar of protection is towards the higher side across the spectrum of insurance because it covers you for life, thereby inheriting the name "whole life" - it stays with you till you depart or until you reach the revered age of 99 (for most contracts), whichever is earlier.
The reason for the higher cost of protection is the advantage of having lifelong coverage, level premiums and guaranteed insurability. This means that the premiums you agree to on the contract will be the amount you will continue to pay for the rest of the insurance term and will not be varied unless you alter the contract (true for most policies across the local industry). Guaranteed insurability means you will continue to be covered regardless of any changes to your state of health within the term of insurance. This is a golden factor for consideration most people miss.
Whole life insurances are a flexible innovation by nature. When incepted at a younger age (optimally below 30), you benefit from the longevity that bestows you (assuming you live till the national average age of life expectancy). The premiums you pay every year will therefore reap a non-linear return as each year passes; this is due to the mathematics of compounding; liken this to the large waves generated from a very long fetch across the vast oceans, where wind is strong and there are little obstructions.
Most whole life insurances are participating. This means premiums paid are partly allocated to a participating fund managed by the insurance company. Participating funds usually invest in a broadly diversified range of financial assets which carry credit ratings of above investment grade. Ever year, insurers declare a bonus dependent on the performance of the participating fund. These bonuses will eventually be credited to your insurance policy. Over the decades, you can see the power of compounding work its magic. But of course it takes time.
I always tell my clients not to treat their insurances, especially whole life insurances as an expense but rather a forces savings mechanism. Only part of the premiums you pay finances the cost of insurance, the rest is invested to reap you returns. Over time, if one is patient and values the importance of protection, he will be rewarded with a generous payout. This is why this particular breed of insurance can be used as a retirement savings pool on top of the financial protection it offers.
To sum up, whole life insurances are optimal for young adults who have streams of regular income because they lock in lower costs of protection for life, allow time to work in their favor through compounding of vested bonuses, and therefore ultimately create a retirement savings pool for themselves and their immediate family.
- Control over investments;
- Lowest cost of insurance until a certain age;
- Highest flexibility between protection and investment;
- Non guaranteed returns but potentially higher returns over longer run
Investment-linked insurances, or investment-link policies (ILPs) are fairly recent innovation in the local industry. When I say fairly recent, I'm talking around 15 years back. Readers must understand that insurance itself existed when the first market exchanges were created; when commodities were trades between producers and consumers, insurance was used to hedge against unwanted price fluctuations what affected business. ILPs really gained popularity in the early 2000s because they offered a degree of flexibility that had never been seen before, and is up till today, still unrivaled across the spectrum of insurances.
When I speak to clients that have a lesser understanding about insurance as a whole, they seem to be more interested in ILPs than the traditional whole life insurances and for obvious reasons. Any product that offers consumers flexibility these days insanely stands out from the crowd. We love things that are integrated, and we yearn for convenience even though that means forking up a little more. ILPs suit this tab, albeit not perfectly. There are pros and cons to be considered. But the fact is that my younger clients do prefer ILPs over traditional insurance solutions.
An ILP is different from a whole life insurance in that the owner has the ability to select where the premiums are channeled to. An ILP offers owners the choice of a variety of funds, which are managed by internal or external fund managers. These funds are usually called ILP sub-funds because they are funds that feed directly or indirectly into one or a few mother-funds which are also either managed by internal or external managers. To illustrate the point, a sub-fund of Insurer A might feed into the same mother-fund as the sub-fund of Insurer B because both sub-funds from the 2 insurers have similar investment objectives; although this is rare, it illustrates the point of a sub-fund.
There are many ILP sub-funds available in the local insurance industry all with their own respective risk classes and investment objectives. They might be a pure equities fund, a balanced fund, a fixed income or money market fund - if categorized via asset classes. Premiums paid under the ILP is invested accordingly the predetermined allocation set by the policy owner. Insurers usually allow owners to perform fund switches under the same ILP.
With lots of flexibility also comes many caveats. One of which is returns are mostly non guaranteed. This is the case because the returns on invested premiums are invariably linked to the performance of the sub-funds invested into. Depending on what financial assets a sub-fund holds, returns are always market-dependent. I hope that by now, readers would have understood that the future prices of any market cannot be predicted with full accuracy and consistency. With this knowledge, it is logical why ILPs may see periods of weaker or even negative returns, and periods of higher returns. Yes, it is possible to loose money on a single premium ILP of the prevailing value of the units held under the ILP falls below the average purchase price.
Another caveat is that unless you are a person with some knowhow on matters relating to trading and investment, you will find the deluge of options and moving parts in an ILP to be more confusing that assuring. An ILP is inherently much more complicated than traditional insurances because returns are non guaranteed, and also because of the flexibility offered plus the number of variables involved.
Apart from giving you control over your investments, albeit limited, most ILPs also feature a substantially cheaper protection element. The caveat is up to a certain age, and this varies from ILP to ILP. But it is usually till around 40 years of age.
The structure of most regular premium ILPs is that they allow you to vary the amount of insurance coverage for a given size of premium (i.e. from $50,000 to $230,000 of coverage for a yearly premium of $2,000). If a lower coverage is selected, the amount of premiums allocated for investments is higher, and vice versa. Usually if you contract an ILP when you're still below 25, the upfront difference in costs between a low and high coverage amount is only slight. This is why ILPs are incredibly good for offering individuals of a younger age cheaper protection while granting them all that flexibility I mentioned above.
I never suggest to my clients that they should keep their regular premium ILPs in force for too long a time. This is because as individuals age, the mortality charges (cost of insurance) will start creeping in at an exponential rate, and eventually start amortizing the value of the investments even though premiums are still paid regularly. In other words, the cost of insurance is not leveled, as opposed to the leveled feature of whole life insurances.
In short, ILPs are extremely suitable for younger individuals with higher risk appetites and decent understanding of the markets. They offer cheap coverage at younger ages but mortality charges are not leveled. ILPs are not suitable for older individuals because of the high and rising mortality charges. When managed well, ILPs can be rewarding as they can potentially provide a much higher rate of return than traditional whole life insurances.
Term Life Insurances
- Pure protection element;
- Non participating, no cash value, therefore extremely cheap per dollar of coverage;
- Simple, no frills type of insurance;
- Choice of level and convertible, or guaranteed renewable and convertible
Term life insurances are what most folks would relate the entire edifice of insurance to. Term life insurance is basically what the name says it is - insurance coverage on a life for a term, after which the contract expires. The key difference between term life insurances and whole life insurances is that the former never accumulates cash value, meaning all premiums paid go straight to financing the cost of insurance, also known as a mortality charge, less other expenses.
Because term policies are non participating, the only benefit receivable is when the owner makes a claim under the clauses of the contract. These benefits, whatever they are, are therefore guaranteed under contract but will be contingent on some form of event, and not voluntary termination or maturity of contract. Usually, once a claim is made on a term insurance, the contract terminates automatically.
They key eye catching feature of term life insurances, and precisely why I recommend younger individuals with some spare cash churning in their bank deposits, is that the cost of protection is immensely cheap and affordable for almost anyone with some form of savings and income. Depending on which insurer you go to, the cost per $100,000 of coverage for a 10 year term can be in the ballpark of $100 per year. This is cheaper than the SAF Group Term Life Insurance underwritten by Aviva that all NSF are required to buy when they are conscripted to serve in the military; this policy is automatically renewed even after the serviceman a tenure is up, individuals can choose to terminate the policy or allow it to lapse via non payment of premiums.
Assuming you are of good health and are under 30 years of age, term life insurances are an absolute no brainer. Without revealing too much about my personal insurance portfolio, I myself am covered in my life under a term insurance for a figure with 7 digits. I'm paying less than $2 a day for that protection. And I totally love it.
Another reason why I insist that young individuals own a term life insurance is because of the sheer simplicity of the solution. There are very few moving parts because you are purely dealing with protection. There are no reinvestment risks because term policies are non participating as mentioned, one simply buys protection and maintains the insurance by paying regular premiums, which are quite honestly pennies on the dollar compared to other forms of insurances.
Where term life insurances shine, they also gloom. Just with ILPs, mortality charges rise as you progress into another age band, say from 25-30 to 31-34. If the stupendously low costs of coverage are a boon in your former years, the high costs will be a bane in your latter years.
Fortunately enough, insurers usually attach an option on their term life insurances. This option gives you the choice of switching to a whole life insurance (normally with guaranteed acceptance provided you are in the pink of health) which we know offers very different advantages altogether, as explained above. Owners of term life insurances can switch to a participating life insurance at any point of time during the period of their term coverage. This injects a little flexibility of cost structuring to an otherwise rather rigid solution.
The smart thing to do would be to own a term life insurance if you are on a tight budget or have other legitimate financial commitments, and then switch to a whole life insurance when circumstances improve.
Term life insurances may not be guaranteed renewable after each policy anniversary (policy anniversaries are the dates on which one full year has elapsed since when you started your insurance). I mentioned in the onset that there are usually two types of term life insurances; leveled and convertible, guaranteed renewable and convertible.
Leveled policies allow you to pay the same premiums for the term of the insurance, but they might not be renewable after each policy anniversary. Meaning, if your health deteriorates during term of coverage, your insurer may choose to terminate your insurance on the next policy anniversary even though you might still wish to keep it. This is because the insurer will still be charging you the same premiums even as your mortality risks increases.
Guaranteed insurable polices gives you a guarantee that you will be able to renew your insurance after the passage of each year until the term of the insurance ends. This is irregardless of your state of health during the term of insurance. However, for this benefit, the premiums you pay each year will not be the same as you had previously paid. You forfeit level premiums for the assurance that you can keep the insurance for the duration of the term.
So in short, term life insurances offer superior cost effectiveness on protection when you are under a certain age, after which it becomes cost ineffective and you will be much better off relying on a participating insurance that accumulates cash value. Term life insurance bridges a crucial gap for many aspiring young individuals as they provide crucial protection at a low cost, while providing you with an option to switch to a whole life insurance as you age and start preparing for retirement.
If this article has piqued your curiosity on the topic of insurance, you are more than welcomed to correspond with the author himself.