Last Updated on 15, September 2018
Stroll down to the end of this page if you are looking for the Universal Life Calculator I created.
Universal Life products are often marketed to the high networth individuals. It appears to be very popular in Singapore and Hong Kong. I always get enquires from individuals in these two countries seeking my second opinion.
1. How to get proper documentation on Universal Life?
Many financial advisers and banks do not provide sufficient information for their prospects regarding the details of Universal Life. So the amount of documentation that a potential client receives is actually very little.
In Singapore, high networth individuals (known as ‘accredited investors’) do not have the legal entitlement to receive important information when investing in products such as Universal Life. If you are a so-called ‘accredited investor’, you need to know that:
- Your financial adviser does NOT need to disclose any terms and conditions, cost and even the name of the product manufacturer.
- Your financial advisers can recommend products to you that are UNREASONABLE and clearly NOT suitable.
- Your financial advisers are permitted to make recommendation even if there is a conflict of interest.
Do not be contented with brochures and marketing materials. Ask for the benefit illustration and product summary. You will eventually sign on the benefit illustration but you need to get it prior to the meeting known as the ‘closing’. The ‘closing’ meeting is a sales terminology referring to the meeting which you make the decision to purchase the Universal Life.
This blog attempts to educate the public on how to select a universal life.
2. Who markets it?
Universal Life insurances are marketed by a number of insurers. But the main distributors are banks. The following are some examples:
- HSBC Asian Wealth Prestige
- AIA Platinum Legacy
- Great Eastern Prestige Harvest
- Manulife Heirloom
- HSBC Jade Global Plan
- Great Eastern PremierLife Heritage
- Transamerica UL Plus
- Transamerica UL Max
3. What is Universal Life?
A Universal Life is simply an investment-linked policy (ILP). In an ILP, the premium you pay is meant to pay for insurance, investments and commission.
Insurance charges are charged on a monthly basis until the policy terminates. These charges are based on age, “sum at risk” and gender.
Consider the monthly charge for HSBC Asian Wealth Prestige an individual wrote to me about (I will use this Universal Life as an example throughout this blog). At 80 years old, the monthly charge will be US$4.582 per US$1,000 sum at risk. Sum at risk is the amount which the insurer has to pay on death. Assuming the death benefit is US$2,000,000 and the cash value is US$600,000, the sum at risk is US$1,400,000. Therefore, the monthly charge is 4.582 x 1400000/1000 = $6414.8 a month. This is equivalent to US$76,977.60 a year.
If the same person survives until 90 years old, the insurance charge is US$11.441 per $1000 sum at risk. This is equivalent to more than 100% in increase in cost!
As it can be seen that all the main flaw of an investment-linked policy – like its escalating cost resulting in the policy lapsing – also applies to Universal Life. Some insurer may offer a no-lapse guarantee. If they do offer it, they will charge for such a feature. A no-lapse guarantee is an assurance from the insurer that they will never lapse the policy even if there is no cash value left due to the escalating insurance charges. It is critical that you ask for a no-lapse guarantee. Some insurers say they have a no-lapse guarantee but the guarantee is only for the first 5 years of the policy. This is as good as no guarantee because the insurance charges are low during the initial years since the client is still young. You need a no-lapse guarantee throughout your entire life.
TIP #1: Ask for no-lapse guarantee for your entire life (not just the first 5 years).
An ILP offers a list of funds to invest. But in a Universal Life, there is only one choice which is cash. Cash in the Universal Life earns a certain interest called the crediting rate. Crediting rates are separately categorised as follows:
- Minimum crediting rate throughout the coverage period. This means the actual crediting rate can never go below this minimum.
- Guaranteed crediting lock rate. This applies for the initial period of say a few years. In the HSBC Asian Wealth Prestige, the crediting rate is always the lock rate during the lock period even if the prevailing crediting rate is higher.
- Prevailing crediting rate. This is the rate which is declared by the insurer.
It sounds very confusing. That is why I always have people emailing me because they just cannot understand all these terminologies.
A number of private banks market Universal Life like a saving/retirement plan. It must be noted that if you are buying for such a purpose, it means there is intention to make partial withdrawal or surrender the policy in the future. If this is so, the returns from the Universal Life cannot be higher than the crediting rate. The actual returns must be lower due to:
- On-going insurance charges and
- Surrender penalty.
You can read about an individual who was misled into thinking that his return will be equal to or more than the crediting rate: https://consultwho.sg/questions/-Overfund--a-Universal-Life-Policy-as-an-alternative-asset-class-189
I have already explained how the premium you pay is for insurance and investments. The third component the premium you pay is for commission. If you are buying the Universal Life in Singapore, the insurer will provide a benefit illustration which would state the total commission you are paying. This is known as the ‘total distribution cost’. Typically, a Universal Life’s total distribution cost is about 10% of your premium. For example, if you are buying a Universal Life which cost US$300,000, the gross commission is around US$30,000.
To find the gross commission, you can refer to the total distribution cost table.
To help you appreciate how large this commission is, consider the following products and their commissions:
- Property: 1% or less in commission.
- Unit trusts: 1-2% commission.
- Corporate bonds: 1-2% commission.
- Stocks: 0.20% or less.
- ETFs: 0.20% or less.
- Singapore Saving Bonds: 0%
If you are financing part of your premium from a bank, the banks earn thrice – one is for selling the Universal Life and another for selling you the loan. The third time it earns a commission from the leveraged portion of the premium which itself comes from the amount borrowed. Here is an illustration on how the bank earns three times and assuming you have US$500,000 in cash only.
- First the bank lends you US$500,000. Hence, the bank earns one time selling you a loan product.
- Next, the bank sells you a US$1,000,000 single premium Universal Life.
- The first US$500,000 comes from you own cash. Hence, the bank earns the second time via commissions.
- The next US$500,000 is borrowed money. Hence, the bank earns the third time.
The ability to leverage up using premium financing means the commission can be leveraged up too. Using the same example above, without premium financing, the commission is 10% x US$500,000 = US$50,000. With premium financing, the commission doubles to US$100,000. Effectively, the commission is 20% of your own capital. I think relationship managers is the best occupation. Forget about engineering, IT and what not.
The disclosure of cost and commissions is in the benefit illustration which is a document that you will sign on the closing meeting. But you may only be given a small part of the benefit illustration prior to the meeting. You should insist to be given the full set although you do not have the legal rights to insist. If you are not given the full set before you sign on the dotted line, my advice to you is that the relationship manager has something to hide because you are going to ask endless questions.
TIP #2: Ask for the benefit illustration. Walk away if you are not given the full set.
4. How to instruct your relationship manager to generate a proper Universal Life?
The benefit illustration has to be properly generated first. The relationship manager has to determine how much premium is required. This is done by running the benefit illustration software and ‘solve to age’ X where X is the age which the policy endows. Let me explain.
When a policy endows, it means the cash value and the death benefit converge to the same value. Effectively this means that there is no more insurance coverage since cash and death benefit is the same. Once the cash value and death benefit converge to the same amount, there is no longer any insurance charges. Insurance charges are extremely expensive for older ages Without these insurance cost, the policy is effectively guaranteed to remain in-force.
My problem with all these software is that the ‘solve to X’ is based on a projected crediting rate. The projected crediting rate used is always higher than the minimum crediting rate. So if the crediting rate fall below the projection, not only the policy cannot endow at X, but may even lapse due to running out of cash values to pay for the expensive insurance cost.
Below is the HSBC Asian Wealth Prestige. The person who generated the benefit illustration set the endow age at 100 (not shown below). This is based on the projected 3.8% crediting rate. But based on the guaranteed minimum crediting rate of 2% per annum, the policy will lapse at age 77 years old. If the average crediting rate is between 2% to 3.8%, say at 2.8%, the policy is likely to lapse at around 80 plus.
TIP #3: Make sure the relationship manager generates the benefit illustration that endows at 100 based on the minimum (not projected) crediting rate. This has to be done by trial and error and is not automated.
You may ask why do they always generate the endowment age based on projected crediting rate instead of the minimum crediting rate? It has to do with competition. When the client compares different products, they always look at the premium vs the death benefit. Obviously any relationship managers who is trying to compete will quote you the lowest premium possible. Once you are attracted to the product, you will be asked to ‘overfund’ your policy. Overfunding your policy means putting more money into the product. They will tell you nicely that there is no need to top-up cash to overfund the policy because of premium financing (thus, they sold you an even larger loan!).
5. How to calculate the appropriate benchmark return for your Universal Life to compare against?
You will need to determine whether the returns provided by the Universal Life is worth the investments. This is important because the Universal Life is often marketed both as an insurance plan providing protection and a saving / retirement product. Hence, there is a need to calculate the benchmark returns required.
TIP #4: If the projected return of the Universal Life is lower than the benchmark return, do not purchase it as you are not rewarded for taking the risk.
The benchmark return consists of the following:
- Risk-free rate. This is the rate of return assuming there is no default risk. The 10-years Singapore Government Securities have been around 2.5% for the past one year. So I just use this figure. The Hong Kong 10-years government bond is around 1.3%.
- Foreign currency risk premium. This is the risk of investing in a foreign currency. Since Universal Life are often denominated in USD, you need to take into account of currency risk. Since USD has depreciated against the SGD by 1.67% for the past 10 years, we just assume the foreign risk premium is 1.66%. The Hong Kong dollar is pegged to USD. For the past 10 years, there has been no change in USD against HKD. So I assume the forex risk premium for Hong Kong residents is 0% per annum.
- The next consideration is the credit risk of the insurer. In Singapore, the first SGD100,000 in terms of guaranteed cash value (per insurer) is protected by Singapore Deposit Insurance Corporation (SDIC) provided the policy is issued from Singapore. Policies issued by overseas branch is not protected. Similarly, the protection is available for up to SGD 500,000 of the sum assured per insurer for death benefits. Thus, the payout in excess of this protection amount is expose to the credit risk of the insurer. The protected amount credit risk is that of the SDIC. Although SDIC is not the government, the SDIC is set up by an act of parliament and thus we can reasonably assume that SDIC’s credit risk is similar to that of the risk free rate. For policies issued in Hong Kong, the entire Universal Life insurance policy is not protected at all by the Hong Kong government. (Source: http://www.nortonrosefulbright.com/knowledge/publications/106412/insurance-regulation-in-hong-kong.) The unprotected portion of the policy will require the similar return from an investment grade bond. I just did a brief survey and found that the high investment 10-years corporate SGD bonds and USD bonds are yielding around 3.3% per annum.
The benchmark return is based on the weighted average return of the above. Here is a simple illustration for a single premium USD 306,187 issued from Singapore branch insurer is as follows:
What the above table is saying is that based on the initial premium, the policy need to provide you with a return of 4.77% for it to be worth the risk.
To save the hassle, I have created an online calculator to do the calculation. This brings me to the next section…
6. How to calculate the returns from your Universal Life?
Your Universal Life pays out either when you die (called the death benefit) or surrender. The death benefit and surrender value is different. The former is always more than the latter unless the policy has already endow and this is usually at age 100.
I have created an online calculator to determine the returns of your policy. This will let you compare with the benchmark returns and see whether is it worth the purchase. The following is an example of calculating the returns based on the surrender value at year 41.
The first thing to do is to find out what is the single premium. Surprisingly, a number of individuals I asked do not even know what this means. They thought single premium means the cash they paid. It is not necessary if there is premium financing. The single premium is the amount of money the insurer collects. Also, there is a need to find out what is the Day 1 cash value. This is always available and use by the bank as a basis to determine how much money it will lend you.
The next thing to do is to find out how much loan you have obtained from the bank. The jargon used by the insurance industry is called ‘premium financing’. But the bank may call it with many names such as personal loan, equity loan, overdraft facility, etc. Whatever what it is called, find out how much money you borrowed. The loan you borrow only requires you to pay interest. Also the interest is normally paid every month. Key in these details into the calculator.
Finally, you need to key in the surrender value of the targeted year which you intend to terminate it or the age you think you will die. For this example, I assume at year 41. Do note that if Account Value and Cash Value is not the same, use Cash Value. Moreover, you would also need to key in the death benefit at year 41.
You will also need to select whether are you buying in Hong Kong or Singapore. Singapore residents who are buying the ‘Jumbo’ Universal Life in Hong Kong should select ‘Hong Kong’.
Finally, make sure your name and email is correct and click submit! You will receive the report immediately. Below is a screenshot of how the report will look like: