So I have this friend who only drinks Starbucks coffee. And I’m not talking about cuppacinos, or lattes, or espressos, or the other fancy-schmancy drinks Starbucks is famous for. I’m talking about plain, regular joe, the kind that doesn’t really take any effort to brew. My friend buys a tall “café Americano” every day on his way to work, and pays $4 to drink it out of a sexy Starbucks cup, with a cute little coffee cup sleeve, for a beverage that doesn’t materially taste any different from the home-style brew you’d get at your local coffee shop. Even Starbucks concedes on its website:
“While the Americano is similar in strength and taste to American-style brewed coffee, there are subtle differences achieved by pulling a fresh shot of espresso for the beverage base. The best way to discover these nuances, of course, is to try a cup yourself.”
Translation: Starbucks can’t tell you what the difference is either.
In terms of taste and how well it keeps me awake, I’ll contend that the 50 cent cup of coffee from my office canteen offers just as much satisfaction as a $4 cup of Americano. Just ask my cubicle neighbors, who have to put up with my moans of satisfaction and I slurp my morning cuppa.
Paying more for something doesn’t necessarily mean that it’s better.
We talked a little bit about insurance and why it rocks, but the type of insurance you get matters too – something I learnt the hard way.
6 years ago, my insurance agent scammer financial planner sold me an investment-linked plan that cost me $100 a month for a coverage of $100K. Back then, it seemed like a good idea – I’d be able to invest in a sexy commodity fund, get coverage from death and disabilities and other Scary Things In Life, and when my units appreciated in value, I’d be able to cash out and buy a diving pool filled with crisp bank notes, bitches!!! Or so I thought.
A couple of years ago, I decided to pull back the hood on these ILPs (Investment Linked Plans) – Checking through the prospectus (something I should’ve done before I signed it, but I was 21 years old and clueless) I realized that a huge portion of the premiums paid – around 15% – went straight into paying off my agent’s administrative fees and commissions. On top of that, the funds I was invested in charged a management fee of around 1.5%, absolutely huge when you compare them to the management fees of passive index funds – around 0.1-0.5%. After all the fees and charges, ILPs average a measly return of around 2.5% per annum, which isn’t even enough to beat inflation. Goodbye, superdamnawesome bank note-filled diving pool!
I didn’t know it back then, but I could’ve bought another type of insurance and increased my coverage while paying a lower premium. I could’ve then taken the difference and invested it in a low-cost index fund, and after 30 years would’ve been able to afford that diving pool I was talking about earlier. Whtheck?! Yes indeed – it’s called term insurance, and I’ve officially joined the camp of “buy term and invest the rest”. But more on that later.
The thing is, most insurance agents scammers financial planners will probably try to push the more expensive, frills-laden product on you, simply because of the way their incentives are structured. Agents are paid commissions from whatever they sell you, and it’s a pretty good assumption that the higher your premiums, the more you pay out in commissions. So they’re incentivized to sell you the most expensive plan you can afford, not because it’s the best for you, but because they’re saving up for their own damn diving pool.
So just because your brother-in-law is trying to sell you that sexy investment-linked plan with the high premiums, doesn’t mean that he’s got your best interests at heart. I’d recommend treating all insurance agents like how you would treat financial sleazeballs: do your research, question everything and take all the time in the world to decide. If you live in Singapore, there are plenty of choices for you to choose from – don’t be afraid to shop around. This decision is potentially worth tens of thousands of dollars, so it’s worth taking it slow.
Don’t get me wrong. I’m not hating on all investment-linked life insurance plans. They can be suitable for certain types of people (like people who won’t take 2 hours to read a good personal finance book). But if you’re young and healthy and sexy, I really don’t see any reason why you would fork out more money for a shitty investment. It just doesn’t make any sense.
I’ll be blogging a little bit more about term insurance and why it beats life insurance hands down for young people. In the meantime, how many of you have insurance plans that you’re less than happy with? Do you think we should change the whole structure of incentives for insurance agents? Let me know 🙂
I must admit there are some many truths to what you have explained in this post; The premium breakdown, the cost of the insurance, the management fees, and even taking into consideration inflation and how that plays into the bigger picture; something of which many people seem to over-look.
Even your other posts says a lot as well. That is why I started to follow you because I have an interest in the same thing.
However, there are definitely some inaccuracies in your description and purpose of the kind of insurance.
Now just as a disclaimer, I am not from Singapore. I’m sure the laws and plan designs are different. One great thing you don’t have to worry about is something called Capital Gains tax. But one thing is for certain, there are some worldwide truths that need to brought forward to ensure a proper picture is built in the reader who can reading from anywhere in the world, where their laws, and financial needs and/or requirements are completely different.
One point that was mentioned that made me have the urge to write this reply is your entire 2nd last paragraph…
“Don’t get me wrong. I’m not hating on all investment-linked life insurance plans. They can be suitable for certain types of people, such as older people who have to pay much higher premiums for term plans. But if you’re young and healthy and sexy like me, I really don’t see any reason why you would fork out more money for a shitty investment. It just doesn’t make any sense.”
I would have to complete and utterly disagree with that. To be honest, it’s backwards.
Maybe an investment-linked plan is not for everyone. But then the exact same can be said for term insurance.
Term insurance is cheap. That is for sure, when compared to any whole life or investment linked insurance. But only at point of purchase! In time the cost to maintain that protection will consistently increase. Remember that inflation factor? Well here you go, now you have to pay more to maintain the same coverage. It will come to a point where the person will either cancel their coverage because they can no longer afford it, especially when they retire and their income has been reduced, or it will disappear because they couldn’t keep up with the attempt of paying the premiums. So what are you left with? All the money that was paid into it is now gone. How much was that?
But a common response is, “You don’t need it. You got a lot of money saved up.” Here comes the mantra of “….Invest the rest”. One bad market crash and not only have you lost your retirement savings, but you also have no protection.
Now it was good to read in a previous post the importance of having coverage, and to that I applaud you, but when a person is young, healthy and sexy, that is all the more reason to get a plan that… yes… costs more… but the prices will never change.
The idea of it being useful for “older people who have to pay much higher premiums for term” is not true at all. If you think a permanent plan will be cheaper then a term plan for an old person, then there is more research that needs to be done. A permanent plan WHEN PURCHASED will always be more then a term plan WHEN PURCHASED. IE: comparing them together at the same time, no matter how old they are.
However, a permanent plan will eventually be cheaper in the long run because the prices have not changed, when the term has changed (every X number of years).
Do you honestly think it will be easier for an older person to get insurance protection, or a younger person?
Anyone can have all the money in the world, but if you are unhealthy, no insurance company will touch them.
Think back to when you first got your drivers license. How much was gas at that point in time?
Now ask yourself this…. would you have been willing to pay DOUBLE at that time when everyone else around you was paying standard price? With just that limited amount of information, I hope you would say no. I know I would say no if that was all that was said. It wouldn’t make sense. Why would I want to pay double? Forget it.
Okay… so now lets add to it. If you pay double, you will never have to pay an increase for the rest of your life, no matter what car you drive. Now what would you do? Would you take it? Look at gas prices now. If that option was even available, I would say YES YES YES! Because even today, I would still be saving when I compare to prices that are the pumps.
So now take that same idea and fast forward 20, 30, 40 years. How much further ahead are you? How much have you save now? You got gas for life. No risk of losing the ability to have it.
There is much more value now when you understand the whole picture.
One thing that is guaranteed to happen, is death. Somehow, someway, at some point.
Having a plan that will always be there for when that day comes, sounds a lot better then a term plan that won’t always be there.
Having a plan that is investment linked, may not be for everyone like I said, and may not make sense in Singapore because you don’t have Capital Gains tax. But from where I’m from, we do have to worry about it. And one of the best things about those type of plans for us, is that if a persons retirement savings contribution room has been maximized, they can tax-shelter their money in the investment-linked insurance to grow at whatever rate, so they it still pays out tax free.
Insurance is the most guaranteed way to pay that off if you don’t want it taken out of your estate, and away from who ever you want your estate to be passed on to, like your kids.
One bad heart attack, getting cancer, going through chemo, and any other elderly health problems that can arise will drain your hard earned assets in no time. Insurance can protect that, at a rate that will never change for the rest of your life.
Now I understand based on your experience you went with a person who you feel misguided you. I’m sure there are salesmen out there like that, and probably a lot of people who feel just like you… but one bad person does not represent the world.
And just like you mentioned, and in which I totally agree with, it’s important to self educate. Because not only would it be the salesmen’s fault for not accurately providing all information, it would also be the customers fault for going into it blindly.
Paying more for something doesn’t necessarily mean it’s better…. is true.
But paying more for something doesn’t necessarily mean it’s worse either.
Hi ZeroVain! Wow thanks for the super detailed comment – I think I’ve never had anyone comment on something that’s the equivalent of a blogpost before! I don’t know how term/life insurance is structured in your country, but most plans in Singapore usually have premiums that don’t change for the entire duration of the plan. So essentially, you wouldn’t be “paying more” over the course of your lifetime for term insurance. In fact, with inflation, you would probably be paying less in real terms! (Taking into account the caveat that inflation also erodes your coverage).
You may be right about the bit on premiums for older people, though I don’t know the exact breakdown. I did remember an agent explaining to me once that term insurance increases exponentially as you grow older (if you sign up when say you’re like, 60), which is why I made that comment. But I havent really done a study on insurance premium comparisons for old people so it’s hard to say.
Nevertheless, I stand by my opinion that term is always better for young people. If you’re concerned that you’d be caught in a situation where you’re old, and your investments have tanked, leaving you with no protection, there are term insurance products out there that insure you to up to the age of 100 (by which, I think it’s better to just leave the world knowing you’ve lived a long, full life :)) That is still a better (and cheaper) option when compared to a an investment-linked plan with hefty management fees. Essentially, insurance should be insurance. Leave the investment part out of it, because you can totally do it better with an index fund.
Thank you for the detailed comments! Please keep em coming because it helps me think more about my posts!
Whoa – give your friend a break. Americano coffee differs in every coffee shop with regard to the taste. Starbucks may be pricey but the taste is far more superior to anything its competitors offer – Americano drinker 🙂
Hi. Firstly, I apologise for jumping in with a comment on the topic more than 1.5 years later. Just happened to stumble upon this website from other blogs. And so I thought I could share my two cents worth.
I think comparison between Term Insurance and Investment linked Plan should go beyond pure insurance coverage. As the name suggests, term insurance are meant to provide low cost coverage for a specific period where one deems that the need is substantial. For instance, one with a newborn would like to ensure that in the event of his incapacity to provide for the family (i.e. death, illness, disability), a 20-25 year term plan may be suitable as it provides fund to see the child to tertiary studies/ working age. As for investment-linked plan, it is more for long-term investment, while providing a potential (not necessary so) higher returns than fixed rate securities for the long run. I feel that it is down to each individual’s needs and financial objectives.
I think Lionel focused on the upsides of term plans and the downside of investment-linked plan earlier, so perhaps I’ll just counter it around so that we have a balanced approach.
Some downside of term plans: There is no cash value. The premiums are sunken cost purely for insurance cover. Hence in the event one could not pay for the premiums, the policy will lapse and coverage will cease. Beyond a certain period, reinstatement may also be impossible. Also, there are truly few plans that offers coverage beyond 70 years old and the premiums indeed could be an obstacle. Moreover, since coverage for terminal illness is tagged to the basic plan, when the policy ceases for instance, at 70 years old, coverage for terminal illness ceases too. One should also be advised to go for guaranteed renewability so that developed conditions could be covered.
Some upsides of investment-linked plans (ILP): After the initial front-loading of the premiums, the ILP starts to have cash value. This cash value allows flexibility for one who may need to stop paying premiums to sell away exisitng units to pay for the premiums so that the policy does not lapse. Also, in times of need, partial withdrawal from accumulated values is possible (though not recommended due to deduction effects). ILP offers dollar cost averaging (DCA) investment style and may be suitable for one who is not savvy self-investment. At this point I wish to say that investing directly into ETFs and through other non-insurance Unit trusts options also offers DCA. One one key difference, assuming death after 1 year of contribution. A self-directed investment would return the profit/loss of your accumulated $1200 investment. An ILP (in the case Lionel mentioned before), would return $100,000 for a $1200 premium paid.
Next, I would just comment on the point that Lionel made:
“Don’t get me wrong. I’m not hating on all investment-linked life insurance plans. They can be suitable for certain types of people, such as older people who have to pay much higher premiums for term plans.. . . . .”
I beg to differ. ILP works on an ‘annual assurance charge’ model with a modal factor (usually for every $1000 sum assured) that increases with with every increment in age. Hence, there may comes an age (usually you you reach your 50s) that the annual premiums are not able to cover these charges and the policy would sell from your existing units to fund the premiums. Hence, ILPs are definitely not suitable for older people who has much shorter horizon to ride out the high fees involved during the early years of inception.
Finally, with a little confession, I surrendered my 9-year ILP a few months to lose 50% of my paid premium because it does not meet my investment objectives for the long term.
Hey Vincent, good objective points. Though I would argue that the “upside” of having a cash value in an ILP comes with the cost of much higher premiums – just the point I wanted to make in the post. I still believe that most people would be much better off if they stick with the lower-premium term insurance and invest the rest, which would give them enough when their term plan expires in order to self-insure.
You’ve got a point on the older person part. I was just giving my opinion that if someone had signed up for an ILP when he/she was young and secured the relatively lower premium, it might still make sense to stick to it instead of switching over to another plan with a potentially higher premium. But then again, I’m no expert in insurance structures so that may or may not apply.