Dear Mr Tan,
I bought a critical illness plan. It has a clause that allows the insurance company to revise the premium rate in the future, subject to a cap of 1.5 times. I am worried that the cost may be unaffordable to me. What are your views?
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REPLY:
For most life insurance plans, the premium rate is guaranteed for the entire term of the contract.
The only exception is for a critical illness plan. There is a clause that allows the insurance company to revise the premium rate, if it is necessary due to an increase in claims.
The reason for this clause is:
* the plan covers several critical illnesses, such as cancer, heart failure, etc
* the insurance company is worried that the claim rate for some illnesses may increase significantly in the future (beyond what was projected in the premium rate)
* due to this uncertainty, they cannot guarantee the current premium for many years into the future
If the claim rate is kept within the current projection (which already allows for higher claim due to age), there is no need for the insurance company to revise the rate.
So far, the claim experience has been favourable. There was no need for the insurance company to revise the rate. I believe that this situation should continue into the future.
Thursday, June 28, 2007
Collateralised Debt Obligation (CDO)
Recently, you hear about problems with the sub-prime mortgages in USA. There is a high default rate among these mortgages. The high default has now affected the CDOs that are issued on these assets.
Here is a definition about CDOs from Wikipedia:
Collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product.
CDOs divide the credit risk on a portfolio of fixed income assets among different tranches. They issue senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches(unrated).
Losses are applied in reverse order of seniority and therefore junior tranches offer higher coupons.
Using CDO technology, from one portfolio of generally risky assets a range of products are created, from the risky equity tranche to the relatively lower-risk senior debt.
Lesson: There are many complicated financial products in the market. When things go wrong, it is quite difficult to sort out who takes the losses on the various tranches of the products. It is risky to invest in these products.
Here is a definition about CDOs from Wikipedia:
Collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product.
CDOs divide the credit risk on a portfolio of fixed income assets among different tranches. They issue senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches(unrated).
Losses are applied in reverse order of seniority and therefore junior tranches offer higher coupons.
Using CDO technology, from one portfolio of generally risky assets a range of products are created, from the risky equity tranche to the relatively lower-risk senior debt.
Lesson: There are many complicated financial products in the market. When things go wrong, it is quite difficult to sort out who takes the losses on the various tranches of the products. It is risky to invest in these products.
Structured products advertised in the newspapers
I have studied many of the structured products that are advertised in the newspapers recently.
Here are my observations:
* many products have an element of speculation, ie you will get a higher return if certain events happen; for some products, you may suffer a large loss under other specified events
* the advertisements usually do not give the essential details; you have to ask for the prospectus or the brochure
* it is difficult to predict the likelihood of these events or to calculate the likely amount of the gain or loss (even for an expert like me)
* after paying the embedded charges and the marketing expenses, the products are likely to give a poor return to the investor
Lesson: Do not invest in these products; you are paying a high cost and not getting any real value.
If you wish to take risk, invest in equity directly. If you want a safe investment, buy government or highly rated corporate bonds.
Here are my observations:
* many products have an element of speculation, ie you will get a higher return if certain events happen; for some products, you may suffer a large loss under other specified events
* the advertisements usually do not give the essential details; you have to ask for the prospectus or the brochure
* it is difficult to predict the likelihood of these events or to calculate the likely amount of the gain or loss (even for an expert like me)
* after paying the embedded charges and the marketing expenses, the products are likely to give a poor return to the investor
Lesson: Do not invest in these products; you are paying a high cost and not getting any real value.
If you wish to take risk, invest in equity directly. If you want a safe investment, buy government or highly rated corporate bonds.
Save for children's education
COMMENT IN MY BLOG:
If you are require some money after some years (e.g. 20 years later for children education) and insurance, it may not be good to buy a term plan and invest the rest as Mr Tan said.
At the 20th years, it may be a market down turn or the companies you bought are valued lowly by the market, and you are not able to get a decent returns - though the chances are low if the time is long.
With an endowment fund, all reversionary bonus declared in the past years are guranteed, your are more assured of a reasonable returns and assured cash after 20 years.
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MY REPLY:
If you save for your child's education in a large, well diversified, equity fund, you are able to withdraw the savings over a few years to fund the education expenses. This ensures that you get an average market return and is not affected by the market price at a specific maturity date.
You can enjoy the benefit of a higher long term return from the equity market. This return is likely to be much higher than an endowment plan. You also save on the high charges embedded in an endowment plan.
You also have the option to move to a bond fund closer to the maturity date, and avoid the fluctuation in the equity fund.
If you are require some money after some years (e.g. 20 years later for children education) and insurance, it may not be good to buy a term plan and invest the rest as Mr Tan said.
At the 20th years, it may be a market down turn or the companies you bought are valued lowly by the market, and you are not able to get a decent returns - though the chances are low if the time is long.
With an endowment fund, all reversionary bonus declared in the past years are guranteed, your are more assured of a reasonable returns and assured cash after 20 years.
----------------------
MY REPLY:
If you save for your child's education in a large, well diversified, equity fund, you are able to withdraw the savings over a few years to fund the education expenses. This ensures that you get an average market return and is not affected by the market price at a specific maturity date.
You can enjoy the benefit of a higher long term return from the equity market. This return is likely to be much higher than an endowment plan. You also save on the high charges embedded in an endowment plan.
You also have the option to move to a bond fund closer to the maturity date, and avoid the fluctuation in the equity fund.
Critical illness rider
Dear Mr Tan,
I bought a basic life policy with a few riders (ie accident, critical illness, etc).
I was assured by the insurance agent that all premiums for the riders would be loaded up to a maximum of 1.5 times the original premium.
When the policy document arrived, only critical illness had a written clause that indicates that premium would be capped at 1.5 times the original premium. There is no cap on the other riders.
Is this all right?
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REPLY:
I believe that the premium for the basic policy and all the other riders (except for critical illness) are already fixed at the current rate for the duration of the contract. You can check with the agent to confirm that this is the case. If so, you do not have to worry about future increase in the premium rate for these riders.
The premium rate for critical illness is the only rider that is subject to revision. This is the practice of the insurance industry, and reflects the possibility that the claim on critical illness may increase significantly in the future. In your case, your insurance company has set a capped at 1.5 times of the premium.
I bought a basic life policy with a few riders (ie accident, critical illness, etc).
I was assured by the insurance agent that all premiums for the riders would be loaded up to a maximum of 1.5 times the original premium.
When the policy document arrived, only critical illness had a written clause that indicates that premium would be capped at 1.5 times the original premium. There is no cap on the other riders.
Is this all right?
---------------
REPLY:
I believe that the premium for the basic policy and all the other riders (except for critical illness) are already fixed at the current rate for the duration of the contract. You can check with the agent to confirm that this is the case. If so, you do not have to worry about future increase in the premium rate for these riders.
The premium rate for critical illness is the only rider that is subject to revision. This is the practice of the insurance industry, and reflects the possibility that the claim on critical illness may increase significantly in the future. In your case, your insurance company has set a capped at 1.5 times of the premium.
Index Funds
Dear Mr Tan,
What are your views on index funds?
http://www.sgx.com/psv/securities/etf/documents/isharesmsci_sinprospectus.pdf
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REPLY:
Please read my FAQ. I like investing in index funds due to its low cost. In the case of Singapore, a good index fund is the ST Tracker Fund
What are your views on index funds?
http://www.sgx.com/psv/securities/etf/documents/isharesmsci_sinprospectus.pdf
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REPLY:
Please read my FAQ. I like investing in index funds due to its low cost. In the case of Singapore, a good index fund is the ST Tracker Fund
Application of actuarial know-how
1. Here is an example of how actuarial know-how can be applied in motor-car insurance
100,000 people insure their cars
20% have an accident each year
Total claims to be paid is estimated to be (say) $60 million (average of $3,000 per claim)
Expenses to run the business $20 million
Total is $80 million
Each person has to pay a premium of $800
The insurance company can charge more, to make a profit margin
2. Different premium rates
Not everyone pays the same premium rate of $800
Some people are more accident prone
Some vehicles are more expensive to repair
The premium rate varies according to the type of risk
3. Time value of money
The claims are paid one, two or more years in the future
The premium can be invested to earn an income
This can be used to reduce the premium rate, or to increase
the profit.
100,000 people insure their cars
20% have an accident each year
Total claims to be paid is estimated to be (say) $60 million (average of $3,000 per claim)
Expenses to run the business $20 million
Total is $80 million
Each person has to pay a premium of $800
The insurance company can charge more, to make a profit margin
2. Different premium rates
Not everyone pays the same premium rate of $800
Some people are more accident prone
Some vehicles are more expensive to repair
The premium rate varies according to the type of risk
3. Time value of money
The claims are paid one, two or more years in the future
The premium can be invested to earn an income
This can be used to reduce the premium rate, or to increase
the profit.
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