The Policy Owners’ Protection Scheme (PPF scheme) aims to offer protection to policyholders in the event of the insurer failing. In other words, the PPF addresses the issue of an insurance company going bankrupt. The protection is 100% subjected to caps. For individual life and voluntary group life policies (with the exception of annuities), the cap is S$500,000 for the aggregated guaranteed sum assured and S$100,000 for aggregated guaranteed surrender value per life assured per insurer. My comments:
- When consumers buy life insurance policies, they have to be mindful of this cap. It is quite common for individuals to buy their policies from one insurer if the adviser is a representative of one insurer. It will be unwise to make all purchases from one insurer. It is better to buy from multiple insurers.
- The cap is easily breached whenever one buys a mortgage reducing term (MRTA). It is common for individuals to borrow large amounts of money for their housing purchase. It is common for the borrower to buy their MRTA policy from the bank which lends them the money. Last year I encountered a case in which the bank actually offered a lower interest rate if the borrower buys the MRTA from them. Usually only one MRTA policy is offered. Thus, breaching the cap is highly possible for high mortgage loans. It may be better to split the MRTA into multiple policies from different insurers.
- In my opinion, the cap of $100,000 for aggregated guaranteed surrender value is too low. Many risk-adversed individuals ‘invest’ hundreds of thousands of dollars in endowments. Therefore, diversifying one’s purchase of endowments is the only solution.
- For ILPs with a no-lapse guarantee, the PPF protects the first $500,000 when the insurance company go bankrupt. This is in accordance with the illustration example shown in SDIC website: HERE. My question is this: not all ILPs have this no-lapse guarantee. Are they protected at all?
- Surrender values of Investment-Linked Policies (ILPs) have no protection at all when the insurance company go bankrupt. This is because the surrender values of ILPs have no guaranteed value. For example, if the underlying funds are worth $50,000, it does not mean that the policyholder will get $50,000 if he surrenders the ILP when the insurer is already insolvent. Also, ‘101%’ regular premium and single premiums ILPs have become extremely common in the marketplace. These products are mainly investments in nature. Therefore, policyholders are subjecting themselves to significant risks. It is better to invest in plain vanilla unit trusts in which the ‘surrender values’ are always based on the bid price and not subjected to the solvency risk of a single institution. This being said, ILPs that are issued by insurers residing in the Isle of Man have some level of protection but that is not within the jurisdiction of the Singapore law. Thus, it is important for consumers to seek legal advice from lawyers who are familiar with the law in Isle of Man.
- Universal Life (UL). UL products are common life insurance policies offered to high networth individuals. The high sum assured which usually exceeds millions of dollars means that clients are subjecting themselves to the credit risk of the insurer for the amount not protected by the PPF. For example, if the sum assured is S$5m, the credit risk exposure to the policyholder is S$4.5m for a no-lapse guarantee UL.
In addition, many clients like to pay a single lump sum premium or a limited pay regular premiums. This means that the surrender values of these ULs can easily exceed the PPF cap of S$100,000. Again, policyholders are subjecting themselves to the credit risk of the insurer for surrender values exceeding this cap. Because exceeding the PPF’s limits cannot be avoided, consumers must perform a credit risk analysis of the insurer to satisfy themselves that the default risk is low. The average consumers look for the ‘cheapest’ ULs. To me, they should also look at the credit risk of the insurer to form a more complete picture. The credit risk of the insurer will also impact the crediting rate. For an insurer with a higher credit risk, the crediting interest rate should be higher to compensate the client for taking greater risk, all things being equal. In other words, selecting a UL involves examining sum assured, premiums, crediting rate and credit risk of insurer. An insurer with a lower credit risk should have a more expensive premium all things being equal.
Also, be extremely careful with leveraged ULs. It is common for the consumer to pay premiums for ULs from borrowed money. For example, let’s say the single premium required for a UL is S$1,000,000 and is financed by a S$700,000 loan. The surrender value immediately after the single premium is paid is $900,000 (example only). If the insurance company go bankrupt, the amount protected by the PPF is $100,000. Assuming the recovery rate is 60%, the ‘equity’ of this UL’s surrender value is 100000 + (900000-100000)*0.60 - 700000 = -$120,000. What does this negative value mean? Usually the borrowed money is made in the policyholder’s name. The UL concerned is conditionally assigned to the bank as collateral. In this example, the collateral is less than the amount loan amount. The negative value implies that the policyholder must pay the lender $120,000 to make up for the shortfall. This means when the insurance company go bankrupt, the policyholder has to compensate the bank (which is often the one who sold the insurance policy) !
The last comment on UL is this: What will happen to the UL policy if no-lapse guarantee feature is not available? What is a no-lapse guarantee feature in the first place? ULs that have this feature means that the insurer promises to keep the policy in-force even if there is no more money left to pay for mortality charges. I understand that the no-lapse guarantee feature is not common now because of the low interest rate environment. If this is the case, most ULs sold currently do not have this feature. Thus, it is important for the consumer to obtain in writing whether the UL’s sum assumed is protected by the PPF at all.
When in doubt, always consult a competent financial adviser.
This article was also publish on CPF's website:http://www.cpf.gov.sg/imsavvy/blog_post.asp?postid=506476263-288-3558727502
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