Insurance 101 Guide
The guide that teaches you how to get cost-efficient
insurance coverage
First published 2015
Insurance 101 Guide
Copyright © 2015
All rights reserved.
___________________________________________________________________________
Dear Distinguished Subscribers,
Thank you for supporting us, our blog, and for reading our
financial-related posts. It is because of you that we were able to consistently
grow our viewership in a matured blogging space.
As mentioned in the previous blog post, we have been busy
gathering more information about Direct Purchase Insurance (DPI), an insurance
initiative launched recently by the Monetary Authority of Singapore (MAS). For
personal reasons, we have spoken to investment advisors, insurance agents and
attended a talk organised by a DPI provider (DIYinsurance), all to better
understand how we can minimise our insurance cost while maximising coverage.
We would also like to thank and credit Mr Christopher from
Providend organising the DIYinsurance talk. The talk was extremely informative
not only about the new initiative but also about insurance coverage everyone
should have. You can visit his website at http://www.providend.com/ and http://www.diyinsurance.com.sg/portal/home/index.jsp. You can also visit our website https://investmentstab.blogspot.com/ for more information.
___________________________________________________________________________
Disclaimer
The below content is just an opinion and may
not be factual. It is not intended to be any representation of any sorts and
should individuals want to obtain any form of financial instruments as
discussed below, they should consult their respective authorized advisers. Any
opinions expressed in this report are subjected to change without notice and
any affiliated sites or authors are not under any obligation to update or keep
current the information contained herein. Any references made to third parties
are based on information obtained from sources believed to be reliable but are
not guaranteed as being accurate. This report has no regard to the specific
investment objectives, financial situation, or particular needs of any reader.
Information, tools and articles published are solely for informational purposes
and are not to be construed as a solicitation or an offer to buy or sell any
securities or related financial instruments.
The author of this report shall not be liable
for any damages or losses incurred as a result from the below content and users
are to exercise caution and their own judgement when using these information.
___________________________________________________________________________
Share With
Your Family and Friends!
Feel free to share this report if you think that it is beneficial. However please do not change any part of this report. Thank you.
___________________________________________________________________________
As you all know, insurance is something you pay for but hope
that you never have to exercise it. It is a transfer of risk from you to your
insurance company. Before you buy any insurance, you must first determine how
long you should be covered, how much to be covered, and what type of insurance
to buy. However, I would like to add the last step: who you buy your insurance
from.
For the sake of simplicity, this article does not take into
account the future value of each
cost. This is also a simplified classification of insurance that is meant
for easy understanding of the product.
___________________________________________________________________________
Life Insurance
What
is Life Insurance?
Life insurance is an insurance you buy for your dependents
(beneficiary) when you are alive. Upon your death, the beneficiary will receive
a sum of money (benefits). The sum of money is meant to replace your family’s
loss of income in the event of your death.
1. How
long should your coverage last?
It is recommended that the insurance should last either till
your retirement or until the age your dependents are financially independent of
you, whichever is later. You may also choose to cover for your spouse’s
livelihood for the rest of their life although it is rarely necessary.
Illustration
1:
You have a family of 3 children age 21, 18 and 13. Assuming
they will be financially independent after they finish their university,
approximately age 24, you will have to plan and provide for them 11 years’
worth of coverage (24 minus 13). You may also wish to include a plan for your
spouse’s future living expenses. You will need insurance to provide a source of
income for your family during the period where a mishap impairs your ability to
sustain your family’s lifestyle.
Illustration 2:
You and your spouse have retired and your kids are already
financially independent of you. You wish to ensure your spouse’s livelihood is
not impairs in the event of your death, thus you extend your life insurance
coverage period.
However, when you reach your retirement, you will usually
have a retirement fund for both of you, and your spouse could rely on your kids
for extra support. Thus this extended insurance is rarely required.
2. How
much should you be covered for?
To determine how much you should be covered for, you need to
evaluate your family’s current and future expenses. This varies from person to
person, but they typically consist of loans (mortgage, car and credit card),
dependents’ future education cost, and monthly living expenses. The monthly
living expense is often the more important factor and the insurance should be
planned to ensure a minimal drop in your family’s standard of living.
Basic
costs that you should take note of:
- Current debts (or predictable future debts that you are going to undertake)
- Current income (or income providing a satisfactory quality of life)
- Future obligations (eg. Dependents’ education)
After determining all the “cost” you have to cover, take
that amount and minus away the coverage and savings you currently have.
Examples include mortgage insurance (pays off your mortgage in the event of
your death) and your savings and investments. This is an extremely crucial
stage as you must check carefully what coverage and other sources of wealth you
have to ensure that you do not over-insure yourself unnecessarily.
Illustration:
You are currently 30 years old, married (spouse age 30) with
1 child age 5. You would like to cover your family until your spouse retires
at age 65. Your finances and how much you need to be insured will look
something like this:
Item
|
Amount
|
Total
|
Mortgage Loan
|
200,000
|
|
Car Loan
|
20,000
|
|
35years Living Expenses
|
630,000
|
|
Children Education Cost
|
20,000
|
|
Total Sum Required
|
870,000
|
|
Mortgage Insurance
|
200,000
|
|
Savings
|
15,000
|
|
Investment
|
20,000
|
|
Total Surplus
|
235,000
|
|
Required Coverage
|
635,000
|
Base on the calculations, you would be required to insure
yourself a sum of $635,000 to ensure your family is not affected by the loss of
income that comes with your death.
These calculations are based on the assumptions:
·
Zero inflation rate
(for simplicity purposes)
·
Monthly living
expense of $1,500
·
Children not going to
college
·
Funeral prices are
not included as it varies based on personal preference. However, it is best
estimated to be $6000 as an average.
* For
Singapore readers, do check your Central Provident Fund (CPF) on what coverages
you currently are opted-in. You might have signed up for a housing insurance
(Home Protection Scheme) and life insurance (Dependent Protection Scheme)
without your knowledge as these are mostly automatic opted-in schemes. This can
help you save up on insurance premiums by not double or over insuring.
While it is highly impossible to insure or protect your
entire asset or replace your full income due to its costs, it is important to
use insurance to limit the losses or drastic change in lifestyle, should an
event happen. This can be illustrated using the chart below.
A typical individual’s asset and income level throughout his
life can be as stipulated below, where it increases to a peak, before declining
down. This peak happens during the peak of your career, which then steadily decreases.
Using this curve, we can use it to better understand the level of insurance
needed and the benefits of insurance.
The green and red line denote the level of protection at
different stages of life. When one just started his/her career, he might want
to just have minimum protection just to replace his current income level,
should anything happen to him. As he slowly progresses further, his income or
asset level increase, followed by his commitments as he starts a family. This
then translates to a higher level of protection needed as the amount needed to
be secured is higher. As his commitments decrease, the amount he needs to
insure decreases as well.
Due to costs, it is highly impossible and not recommended to
insure entirely based on the blue line depicted in the graph, although this is
the perfect scenario where most people would hope to achieve. It is a similar
concept to the stop loss. Hence, the above framework to provide a better
understanding of how insurance can be used effectively.
3. What
type of Insurance should you buy?
Before doing any insurance purchasing, it is always best to
understand what type of insurance is available in the market and what are the pros and cons. There are 4 main types of life insurance from cheapest to most
expensive:
I.
Term Life
II.
Whole Life
III.
Endowment
IV.
Investment-Linked
Protection
Term
|
Whole Life
|
Endowment
|
Investment-linked policies (ILP)
|
Temporary protection which up to
a certain age
|
Whole life protection
|
Temporary policy up to a certain
age
|
Duration as specified by the customer
|
Pure insurance tool
|
Insurance + cash benefit function
|
Primarily used for disciplined
savings + investment function
|
Investment + protection function
|
-
|
Invests in the funds managed by
the insurance company
|
Invests in funds managed by the insurance company or external unit trusts
|
Invests in external unit trusts
|
3a) Type of Life
Insurance
I.
Term Life Insurance
This is an insurance that covers you for a specific period
as stipulated by you – eg; 5 years or 30 years. It is the cheapest and most
specialised form of life insurance. It protects the desired risk (death) and
nothing else. If used intelligently, it can be the best and most cost-effective
form of insurance.
II.
Whole Life Insurance
This is an insurance that covers you for your entire life PLUS
a savings feature that provides you with a sum of money if you decide to cancel your
policy during the coverage period. The premiums paid are split into a fixed
percentage throughout the whole period into insurance and investment.
The savings are accumulated by the insurance company
investing a portion of your insurance premiums into funds managed by the
insurance company. The insurance agent also draws a higher commission from
selling such insurance contracts, so less of your premiums are actually paid
for protection or for savings.
Illustration:
III.
Endowment Insurance
Endowment policies are designed to pay out the benefits when
the insured person dies within the insured period or when the maturity of the
policy is reached. This is like a term-life insurance contract with a savings function
embedded. While the returns from such policies are not high, they can be used
to enforce discipline to save.
* You could purchase term-life insurance and use the difference in premiums between term-life and endowment policies to invest for
higher returns or put it in a Fixed Deposit, where you most likely will not be
able to touch the money and can get a better return.
IV.
Investment-Linked
Policies (ILP)
This policy is similar to whole life insurance policy;
however, the difference is in the amount of your premium going towards your life
insurance and the savings/investment portion. While whole life insurance’s
premium is split into insurance and investments in fixed proportion throughout
the whole period; ILP usually put more of your premiums into the investment
side when you are young, gradually shifting more towards the life insurance
side as you age. Although most people buy into such an insurance policy to achieve
investment and insurance coverage, they end up being inadequately covered for
both.
The reason for this shifting from investment to protection
as you age is because you need more protection coverage as you grow old. The
less money you have in your investment, the less you can draw out when you wish
to, which is not necessarily a good thing when you are in your retirement
stage. Beyond that, the returns generated by such policies are usually pretty
low, ranging between 3%-5%.
Illustration:
|
$1 of Premiums paid
|
3b) What insurance should you
buy?
This really depends on your individual needs and
requirements. If you would like to have purely insurance protection,
term-life would be more worthwhile. However, if you like to have insurance
linked with investments or savings, then the other 3 insurance policies are
also worth considering.
4.
Who should you buy your Insurance
from?
When we did research on insurance agents’ commission, we found that each agent will earn
approximately 40%-70% commission from the first premium paid by their new
clients. They will continue to draw commission from the premiums in subsequent
years but in smaller proportions.
While it may
seem that we are paying a lot to insurance agents, they actually provide great
help when it comes to handling your claims when required. From personal
experience, we know that it is difficult for individuals to handle the
paperwork required to make claims.
It is
recommended that you approach agents whom you are comfortable with and whom you
know which insurance company they have links with as it is possible for agents
to have linkages with up to 3 companies.
There is a method you could employ, which is to purchase a DPI from a provider and should
you need to claim from the insurance company, the service personnel would
assist on the matter. This is not only cost-effective but also achieves the
purpose of insurance. However, do note that this is still a relatively new
concept.
If you would
like to find out more information, do visit and drop us a comment at https://investmentstab.blogspot.sg/
Summary of the general
characteristics of each type of insurance
Term Insurance
|
|
Advantages
|
Disadvantages
|
|
|
|
|
Whole Life Insurance
|
|
Advantages
|
Disadvantages
|
|
|
|
|
Endowment Plan
|
|
Advantages
|
Disadvantages
|
|
|
|
|
|
|
Investment-linked
policies
|
|
Advantages
|
Disadvantages
|
|
|
|
|
|
|
References
www.diyinsurance.com.sghttp://www.investopedia.com/articles/pf/06/insureneeds.asp
http://www.forbes.com/sites/lawrencelight/2013/04/29/how-much-life-insurance-do-i-need/
this is so well-written!! very comprehensive.. are you an insurance agent?
ReplyDeleteHi Llama
DeleteThank you! 😁
And no, we are not insurance agents