What type of life insurance should you choose?

While shares and bonds and time deposits are more traditional investments, a large number of Singaporeans also use life insurance policies for long-term investments. Indeed, consumers here hold more than 13.1 million life insurance policies and insurance now accounts for 9.3 per cent of households’ net worth.

A key question some investors may have is whether buying a whole life insurance policy as an investment is better than buying a cheaper term insurance policy and investing the difference elsewhere.

TYPES OF LIFE INSURANCE

It is important to start by looking at why one should buy life insurance at all.

Fundamentally, the goal of life insurance is to make sure beneficiaries such as young children or elderly parents have enough money to pay for their needs if something happens to the breadwinner in the family. There are several types of life insurance that can achieve this objective.

The simplest option is term life insurance. You pay a premium, and the insurer guarantees that it will pay your beneficiaries a fixed amount if you’re not around. Term life insurance covers you for a pre-determined amount and duration. Payments go entirely towards insurance, so there is no cash value after the policy ends.

Another alternative is a life insurance policy which includes an investment component. Consumers can buy a policy which uses part of the premium to pay for life insurance and give the rest to the insurance company to invest. Premiums are significantly higher than for term insurance.

One option with an investment component is “whole life insurance”, which covers you for your lifetime and also provides long-term savings. A portion of your premiums go towards insurance protection, which pays out a lump sum if you die, while the rest is invested by the insurer and pays a guaranteed minimum return, as well as a bonus in some cases. The Life Insurance Association of Singapore (LIA) says that whole life insurance guarantees lifelong protection as long as your premiums are paid, and it builds up a cash value which you can withdraw or borrow against.

A more complex alternative is investment-linked policies (ILP), where the value depends on the performance of the investment. You can purchase ILPs with a single premium, or pay premiums in regular instalments and have the flexibility to adjust your insurance amount. For ILPs, the LIA noted, the performance of the funds is not guaranteed and the value can rise or fall, so the maturity values will be adversely affected if a fund performs poorly.

WHICH TYPE OF INSURANCE IS BETTER

The first step when considering life insurance is to decide whether you actually need it. If you have children or parents or others who are dependent on your income, life insurance is important for making sure they can live well if you’re not around. If you have no dependents, then it may not be that important.

If you do need life insurance, the next step is to look at which type of coverage to purchase.

When your goal is to provide for your spouse and children until they are financially self-reliant, term insurance may be all you need.

If you want an investment along with insurance, you can then decide whether to buy a whole life insurance policy or to buy term insurance for a far lower price and invest the difference.

On the one hand, whole life insurance offers the benefit of making sure you invest regularly. While the concept of buying term insurance and investing the rest may sound good, research by Wharton University Professor David Babbel and Carnegie Mellon University Assistant Professor Oliver Hahl showed that many consumers who buy a term life insurance policy don’t actually invest the difference and spend it instead.

On the other, you may earn more by buying term insurance and putting the rest in ETFs or other investments that have lower fees and provide better returns. While data from Singapore is limited, non-profit organisation Consumer Reports in the US compared buying whole life insurance with buying a 30-year term policy and investing the difference in conservative treasury bonds. Assuming just a 2.17 per cent annual return, the bonds provide a higher return, but no death benefit past age 69. After two decades, however, the returns on whole life start to exceed the return from the term-plus-treasuries alternative. If you earned more than 2.17 per cent on your other investments, though, it could take three decades or more for whole life to provide a better return.

Many buyers also underestimate how difficult it can be to keep up with the high premiums for whole life insurance. National financial education website MoneySENSE noted that the guaranteed cash values of bundled insurance products may be less than the total premiums paid.

NEXT STEPS

Considering whether to buy life insurance, and whether to purchase term life insurance or life insurance with an investment component, is prudent. When you shop for life insurance you can use CompareFIRST (www.comparefirst.sg) to evaluate policies.

Rather than just following the crowd, or assuming that either whole life or term life insurance is better, it is important for investors is to consider the multiple options carefully before making a decision on what type of life insurance to buy.