Types of Insurance and Coverage - Part 2

Confused by all the plan out there and bombard by your advisor with all the bombastic words or terms?

Here is what I have promised to deliver - Simple example and layman term to understand the complex product. In order to provide you with a clear picture so that you can make an informed decision, I'll break this Topic into 5 Parts, so read on.

These 5 Part Series are written in a way where you can analyze for yourself base on the non biased information provided ( Both Benefit and Limitation are highlighted). You can then determine for yourselves whether this Financial Product suits your circumstances, characteristic and requirement. I will also provide a summary in Things to Consider to further simulate your thinking.

Note: My 5 Part Series on "Types of Insurance and Coverage" are NOT written with the objective to provide answer but rather provide simulation for your thinking and to analyze.


Part 2

We shall explore the first 2 Types of Insurance Plan in this Part 2 of 5.

1) Term Insurance

Description:

I call this a TOTO plan. It "Strike" which pays if something happen to you (depending on the Types of Coverage you add to this plan) and the insurance company will take your "Bet" which is your premium if nothing happen to you. Generally you can buy this plan for a certain number of years e.g. 5, 10,15, 20, 25 or even up to 99. (Just like your TOTO, you can buy your favorite numbers for just one day or you can buy for one week and even lifetime!)

Benefit:

a) The most economical Type of Insurance - Low Cost, High Insured Amount. Most of the time cost only a fraction e.g. 1/10 of the other Types of Insurance with the same insured amount.

b) Mainly for someone with a budget issue or for boosting temporary coverage e.g. covering the extra liability of 20 to 25 years when there is a new born baby in the family or just personal income protection up to retirement age e.g. Age 65.

Limitation:

a) No surrender value or cash value. Meaning you do not get back any money if you terminate the plan by choice (e.g. you write in to terminate or the term of coverage ended) or by mistake (e.g. forgot to pay premium). It is very common that people terminate this plan by mistake because they were either too busy with their life and forgot to pay the premium even after the grace period which insurance company normally offer or might have change bank account number without re-activating their GIRO instruction. All it takes is just one carelessness out of the 20 or 25 years of term that you chose to cover and the plan is terminated!

b) Inflation will shrink the value of the money. E.g. $100,000 in 25 years down the road is only worth about $29,530 of today purchasing power base on a modest 5% p.a. inflation rate (Current inflation rate is already more than 6%). Just like you can buy a bowl of noodle 25 years ago at less than $1 but now you will need averagely $3.50 to buy a bowl of noodle.

Things to Consider:

There are various Types of Term Plan available in the market e.g. Decreasing Term or commonly known as Mortgage Insurance, Increasing Term, Natural Premium Term and Level Term for your consideration which I'll explain one by one:

a) Decreasing Term or Mortgage Insurance is a Term Plan that will reduce in Insured Amount yearly base on the selected inflation rate but premium remains the same throughout the Term of Coverage. Commonly use for covering the outstanding loan of a property. This is the lowest cost term plan compare to the rest of the Term Plan.

b) Increasing Term is a Term Plan that allow increase in Insured Amount yearly with increase Premium to hedge against inflation. For people who still prefer Term for their overall planning but wish to keep up with the inflation as "Buy Term Invest The Rest" (BTITR) is getting popular.

c) Natural Premium Term, which is also know as Yearly Renewable Term, is a Term Plan that will increase in Premium yearly while the Insured Amount remains the same. This feature can also be found in an Investment Link Policy. For people who do not want to pay anything more than they need and calculate to the last cents worth, this plan might suit them in some circumstances. ( Read: http://www.waynekoh.com/2008/08/saf-group-term-insurance.html )

d) Level Premium Term is a Term Plan that both Insure Amount and Premium remain the same throughout the Term of Coverage. This is the most commonly available term plan in the market where most agent / adviser will market due to easy explanation and for the client to understand. For everyone who find a standard no frill Term Plan is the solution to their Financial Planning and Risk Management.

Is "Buy Term Invest The Rest" (B.T.I.T.R) a good strategy? We will discuss this in future article and not here.

2) Endowment

Description:

Endowment is basically a "Saving Plan" where you choose a Period or Term to save e.g. 5, 10, 20 or even 30 years and will pay you a lump sum of money (Normally capital plus interest) when the Period or Term ends.

Benefit:

a) Force Saving for those who need a little penalty to help them resist the temptation of spending away the critical sum of money which they had finally accumulated.

b) Mainly for people who are risk adverse but wish to have better than bank saving return over a period of time with a specific purpose on the use of the maturity money e.g. To accumulate enough fund to start a business, go on a dream vocation or buy the dream car at age 40 but more commonly use as Education Funding for the child.

Limitation:

a) The most Expensive types of insurance where you pay the highest premium to get a low Insured Amount. If Protection is your concern, then this plan is definitely out of your consideration as you can insure a much higher amount with a Term Plan, Whole Life Plan and even Investment-Link Policy with the same premium.

b) The main bulk of the bonus is only given at the end of the Period / Term and Insurance company have the right to adjust the bonus rate or even remove it totally due to adverse economy. That is the reason why it is so important to ensure this kind of plan to have a high guaranteed return than the variable bonus.

Things to Consider:

There are various Types of Endowment Plan available in the market e.g. Pure Endowment, Anticipated Endowment and Single Premium Endownment for your consideration which I'll explain one by one:

a) Pure Endowment is a standard no frill type of Endowment where you can only get back your money with interest at the end of the chosen Period / Term. Any early termination of the plan will substantially set your financial position back by many years as you might not get back your capital even!

b) Anticipated Endowment is a modified Endowment Plan where you can start receiving money call "coupons" from 2nd years onwards base on 5% or 10% of the Insured Amount depending from company to company. Some company pay "coupons" every year from 2nd years onward, some pay every two years. Some even pay every five years but not as common and useful compare to the prior. The "coupons" paid can usually be re-invested or be withdrawn anytime to provide flexibility for people who like to play safe so that they will not be caught in the event of poor cash flow.

c) Single Premium Endowment is basically an Endowment Plan that accept single lump sum to be invested instead of investing regularly. This is different from paying premium in advance which most types of insurance plan allows. For people who had inherited a sum of money or wish to set aside a lump sum of money for retirement without taking taking too much risk. This type of Endowment generally break even faster compare to Pure Endowment and Anticipated Endowment.

Is Endowment the best plan for Education or Retirement? We will discuss this in future article and not here.