Understanding bonuses in life insurance
If you don’t have time to read through the whole article, you can check out our short version below:
- Both participating and non-participating policies have a guaranteed payout, called the sum assured. However, participating policies have non-guaranteed benefits which can be added to the sum assured.
- For participating policies, the amount of bonus you receive depends on factors such as investment performance and level of expenses incurred by the participating fund.
- Surrendering your life insurance policy prematurely may result in a financial loss.
Regardless of your financial situation, an unforeseen event may unravel and cause tremendous stress to you and your family both emotionally and financially. Hence having insurance is crucial as it provides a financial safety net for you and your loved ones when the unexpected happens. However, many may be overwhelmed by insurance jargon, terms & conditions, and mystified by how insurance policies work.
Read on to find out more about insurance bonuses and how they affect the returns to your insurance policies.
About whole life insurance
Whole life insurance provides lifelong coverage and protection in the event of total permanent disability (TPD), terminal illness (TI) or death. Whole life insurances are available in many different forms and one way in which we can differentiate them is through Participating (Par) and Non-Participating (Non-Par) whole life policies.
Participating (Par) policy vs. Non-participating (Non-par) policy
Let’s look at the key differences between par and non-par insurance policies.
|Participating Policy||Non-participating policy|
|Bonuses and Dividends||Entitled to receive non-guaranteed bonuses (Based on performance of participating fund)||None|
|Pay-out||Sum assured + Non-guaranteed bonuses||Sum assured only|
|Surrender Value||Cash surrender value (Based on policy) + Non-guaranteed bonuses||Cash surrender value (Based on policy) only|
Both par and non-par policies have a fixed payout which is called the sum assured. However, premiums of par policies are pooled together by the insurance company into a life fund which typically invests mainly in fixed income assets. For instance, in 2019, insurers’ life funds’ allocation into bonds ranged between 56% and 68% and the equities’ share was 15% to 29%. This results in par policies having non-guaranteed benefits which can be added to the sum assured.
Common types of non-guaranteed benefits
There are 2 common types of non-guaranteed bonuses that may be added to your insurance policy:
The reversionary bonus is declared regularly (e.g. once a year) and is added to the sum assured, forming part of the guaranteed value of your policy.
You will receive the reversionary bonus in full when the policy matures or when there is a claim paid. However, if you surrender the policy before the maturity date of the policy, you will only receive the surrender value of the accumulated reversionary bonus, which is only a portion of the accumulated reversionary bonus.
The terminal bonus is payable when the policy reaches maturity or when you surrender the policy, or upon a claim for the policy’s benefit. This is typically one-off and is a proportion of the accumulated annual bonuses to date.
How are bonuses determined?
For participating policies, the amount of bonus you receive depends on a couple of important factors including:
- Smoothing Policy
As insurers want to avoid large fluctuations in the non-guaranteed bonuses declared from year to year, they adopt the strategy of smoothing bonuses for its participating policies. The smoothing policy refers to holding back a portion of bonuses in years where the fund has achieved good performance so that bonuses can be maintained during years of poor performance. Thus, bonuses may not necessarily follow the short-term movements in the investment markets.
- Investment Performance
The investment return on the participating fund and its future outlook.
- Level of expenses incurred
The insurance firm incurs expenses to maintain the participating fund. These expenses include life insurance claims paid to participating policyholders, management, investment, tax, marketing, distribution, and other expenses.
Thinking twice before buying an insurance policy ...
Projected Returns vs. Real Returns
Before deciding on which insurance policy to buy, it is important to note that the projected or illustrated returns of your par policy (you can find this in the Benefit Illustration document) do not represent the actual returns you will receive.
Do note that from 1 July 2021, the upper bound for par policies’ projected return will be reduced to 4.75% from 4.25% while the lower bound will be revised from 3.25% to 3%. The lowering of the rates does not have bearing on the actual return because they are projected rates meant for illustrative purpose. However, there is a possibility that insurers may reprice or redesign their product line-up moving forward.
One way of evaluating an insurance product is to find out the guaranteed cash values of the policy, as that is what the insurance company is obligated to pay to policyholders.
To avoid getting a rude shock, ask your insurance agent to provide an updated projection of your cash value from time to time. This will better reflect the policy value as it will change over time due to the par fund’s performance, the investing environment and claims experience. Doing so will help you decide if your policy has broken even, if it makes sense to surrender and at which point.
You may also seek assistance from a Wealth Planning Manager at DBS to help calculate the effective or net returns on your policy benefits based on the projected investment returns stated. As a policyholder, your net return is considerably lower than the projected value after taking into consideration expenses for management, distribution and claims paid.
Surrendering your insurance policy
Should you surrender your policy prematurely, there is a possibility that you might suffer some losses or end up with zero cash value. You should also be aware that surrendering your policy also means that you lose all future financial benefit and insurance coverage that the policy would have provided.
For par policies, cash values normally build up after a minimum period. You will then receive a surrender value if you cash in on your policy, and this value includes a portion of the bonuses that have been declared.
On the other hand, for non-par policies such as a traditional Term Life plan, they typically do not have any cash value upon surrender or when the tenure ends. If it does, make sure to find out how much you will receive when you cash in on your policy, as it may be lower than the total premiums you have paid.
Buying insurance is a long-term commitment so it is essential to learn about the finer details to better understand how it can assist in providing financial security for you and your family.
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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.