My friend ping me a few days ago regarding an insurance policy that he bought long ago.
When he was 19 years old, he bought this whole life policy from a Great Eastern agent.
A whole life policy is an insurance policy with cash value. The primary role in insurance is so that if you passed away, your dependents can have a sum of money to carry on with their lives.
Based on the name, the policy is to cover you for the whole of your life.
The climate has really changed regarding whole life policies. In the past, advisers can still argue that if you get the alternative to whole life, which is a no-cash value term insurance, you will get nothing back whereas with a whole life policy like the Great Eastern policy that he bought in 1988 when he was 19 years old, he would at least have some cash value today should my friend choose to surrender.
My friend is 56 years old today and was wondering whether it is a good idea surrender the policy.
Make Sure That You Do Not Depend on the Policy for Protection Currently before You Surrender the Policy
I told my friend that he should think carefully about a few things before deciding to surrender the policy.
Firstly, he should have an idea what does this Great Eastern policy protect against, and also what is the role of this policy play in his wealth protection strategy.
The biggest problems for many is:
- They have no idea what this policy is about.
- What are their wealth protection strategy.
Sometimes, you need to take part of the blame instead of only blaming the people selling you a dud. If you get it wrong one time, its ok. If you get it wrong two time, still ok. If you keep making the same mistakes then we can’t always keep blaming people.
My friend’s whole life insurance make sure that if he passes away, his wife and child have money to fend for themselves. The policy does not have any riders such as critical illness, or disability income tied to it.
If there is, then the policy may serve the role of providing critical illness protection for the whole of his life.
More and more, I find critical illness playing a more significant role in our wealth protection. If my friend’s whole life policy has critical illness, I would urge him to consider keeping it.
My friend did a review and concluded that should something were to happen to him, he is covered with enough insurance, or his net assets is adequate for his dependents.
If you are considering about surrender your policy, make sure that you review this part first.
If you find that your health has weaken and might have insurability risk, you have to make sure you really don’t need more coverage because you might not get the same degree of coverage should you calculate wrongly and need to get a fresh one.
Get an Updated Benefits Illustration of Your Insurance Policy to Find Out the Revised Projected Value
I ask my friend to request from his insurance company an updated Benefits Illustration.
The revised Benefits Illustration will show my friend his updated coverage and surrender value. The past project he has (probably lost it) 37 years ago is likely not valid anymore.
My friend needs what is likely to go forward to help him make clearer financial decisions.
Here is a glimpse of what he got:
The date at the top right corner tell us this is an updated benefits illustration. We can see when he got it at 19, the sum assured was $50,000.
Is $50,000 adequate coverage for a 19 year old in 1988? Based on an inflation rate of 3%, this is equivalent to $149,000 today.
Observe that the Guaranteed Death benefit is $131,095 for my friend today and the Total death benefit, which includes the non-guaranteed benefit is $148,062. The benefit kept up with inflation!
However, you would know today $149,000 may not cover much. My friend must be a young man with not many dependents back then and naturally this whole life policy cannot be adequate and he would need to add on more coverage back then. But I wonder if full coverage with cash value whole life insurance will leave enough for his other financial commitments and future goals.
We also saw a stream of updated total surrender value.
If my friend surrender the policy today he will get a total surrender value of $65,149.
He would have broken even since the total premiums he has paid till today is $35,142.
My friend wonders if he should surrender the policy and re-allocate the money to other financial goals or investments.
How should he evaluate that?
How to Compute the Returns of the Whole Life Policy So That We Can Review Performance
I told my friend that a whole life policy is not to give you high returns like investments. Since the majority of the participating fund of the insurance company invest in fixed income, then the performance should show some fixed income characteristics.
My friend should look at it more like savings. If he wishes to make his money work harder, then he can choose to redeploy the money into investments.
However, we need a way to measure performance.
I helped my friend calculate the XIRR of his experience owning this Great Eastern whole life policy. I factored in:
- The premiums (inflows) that he has paid this 37 years.
- Any cash back or income (outflow) that he has received.
- If he were to surrender this policy today, what value (outflow) would he get back.
What we have is an “interest yield” that he earn for making this decision to lock up his money in this policy.
This is a compounded return that factors in the time value of money, and also money-weighted.
I have used the same method to review a lot of the insurance policies my readers have crowd-sourced for me in the past.
Does your Insurance Saving Plans (Endowment) give you 3 to 5% returns?
This is also how we compute returns for Providend’s clients various financial goals that reside in different accounts.
Here is the calculation:
If he were to surrender today the annualized return is 2.94%.
My friend should look at this as the return for putting away in an insurance participating fund invested mainly in fixed income with a low equity allocation. I think is decent for my friend considering he is not taking on equity risk. I would often hear people gripe that the returns are so low relative to some other investments. You need to recognize that you might be taking on more risks.
he can take this figure and see if he is more risk-seeking what can he earn.
But more so, I hope you is clear about what life goal he is allocating this amount of money for.
Surrendering His Whole Life Policy Today Might Not be the Most Optimum
I decided to check up something with some of my Havend colleagues. Eddy, my boss and CEO of Havend remarked that old policies can have pretty good projected return rates.
The projection rates of these policies used to be in the range of 6-7% but the rates is 4.25% currently.
Eddy shared that whole life typically work on averaging mortality costs. This means the policy tends to charge the cost of insurance in the earlier years rather than the later years. If a policyholder crosses the breakeven between the total premiums paid, then the returns become better and better.
I don’t think this is always the case but Eddy has been in the industry for a long time and you tend to have a unique gut feel due to your observation.
I grew to pay attention to people who has seen more in certain areas.
Since Great Eastern provided a list of revised projected values, I decide to calculate the XIRR if my friend surrender at various ages:
Now we have some interesting data!
Eddy is right to a certain degree. The compounded returns go up, if my friend gets the revised projected value. You can see a big jump at 59 years old. The returns stagnate after 69 years old.
My friend remarked “If I choose to invest in various allocation of equity and fixed income, I can get higher return. But thanks for doing this. The stream of compounded returns gives me clarity if I am missing out on anything if I were to hold on. And it looks like I might not missed out much.”
End of the day, that is what I want to achieve when helping a friend. Have an open conversation, and be able to help him or her consider what is necessary, maybe share a little of what I know (if I know).
We all want clarity because if we have that, it will be easier to make decisions.
Ultimately, the decision to surrender or not lies with my friend.
I wonder how many of you are in a similar situation as my friend. If you are, perhaps you can consider a similar step by step way. Make very sure you know whether you need the insurance or not. Cannot stress that enough.
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Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.
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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.
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