One of my client sent me this webinar video on legacy planning. The first 11 minutes is educational and I generally agree with the speaker. So you can safely watch first 11 minutes without much harm. But after that, it started selling "koyok" - Universal Life.
The speaker uses Universal Life as a debt cancellation tool and as well as the income replacement tool so that the deceased family will not suffer significant financial lost. I agree that insurance is an effective tool for such a purpose but I have a lot of problem with using Universal Life.
The speaker quoted a Universal Life for a doctor (presumably the speaker’s client) who is last age birthday 44. For a single premium of US$300,000, the death benefit of the Universal Life is US$1,250,000. Do bear in mind that the Universal Life is positioned in the example as the debt cancellation tool and to provide his wife enough money of two years so that she can go back to work.
When I heard that, I almost fainted. In fact, under the Balance Scorecard regime, the adviser who sold the Universal Life in this manner would have committed 5 major infractions. The supervisor who approved the case would also have committed the infraction. This is because the product recommended for such a case is clearly NOT suitable.
Here are the reasons:
Major Infraction #1: A Universal Life provides coverage for life (assuming its cash value can pay for all its escalating mortality charges). But mortgages by nature would eventually be paid off and dependents will not be dependents forever. Thus, the time horizon to support dependents and to cancel debt is around maximum 20 years assuming the doctor works until 65. For discussion sake, I just assume 20 years.
Since the Universal Life provides lifelong coverage, the time horizon is mismatched. One of the most important Non-sales KPI 2 Balance Scorecard is that the product "is aligned with the client’s investment horizon". Thus, the usage of the Universal Life to cancel the mortgage and to provide the dependents is not suitable in terms of time horizon.
Major Infraction #2: The adviser would have breach Non-Sales KPI 3(k) under “Warnings, exclusions and caveats in relation to the investment product”. The warning is that the investment product is overpriced by 625% time. I randomly took Aviva MyProtector Term Plan for a male doctor next age 45, 20 years coverage at US$1,250,000 for death only. The premium is only US$2,069.15 a year. Note that this is not an endorsement of Aviva and there could be other cheaper term. For a 20 years time horizon, the total premium is 2069.15x20 = US$41,383. Thus, the Universal Life is overpriced by a whopping 300000/41383 – 1 = 625% !
In fact, it will be better to just put US$300,000 in a fixed deposit. If the interest is just 0.6897%pa, the interest of the fixed deposit can pay for the term insurance for free. Oh, by the way for a high salaried doctor, the US$2069.15 annual premium is as good as zero. If a doctor can afford US$300,000, the doctor can also afford US$2069.15 a year. There is no need to take on any premium financing! Premium financing will raise the TDSR and affect the ability to take on more mortgage loan to buy properties (Singapore #1 addiction).
Major Infraction #3: There was a calculation error in the needs analysis. In the example in the video, the client pay US$300,000 to buy a Universal Life of US$1,250,000. On his death, there was a mortgage loan of US$900,000 and the speaker said that US$350,000 is left behind for his wife as cash. This calculation is incorrect. When the client paid US$300,000, he becomes poorer by US$300,000. Thus, on his death, his wife inherited an estate that is US$300,000 less (before any insurance payout). Thus, the effective amount she gets from the insurance is 1250000-900000(mortgage)-300000(the premium paid) = US$50,000. Normally there is no need to make such adjustment because premiums for insurance should be negligible relative to the sum assured but for Universal Life the premium is so large that it has the effect of decreasing the estate. I would say this infraction comes under KPI 2 under the “assumptions” used in the recommendation. In this case, the speaker’s assumption did not take into consideration of the prior reduction of the client’s estate by US$300,000. Of course, some advisers will point out that there is a significant cash value. But this cash value is not refunded on death. Hence, the Universal Life acts like a term insurance on death because a term insurance normally does not refund the premium as well.
Before someone jump the gun, I am aware that Universal Life's premium is almost always come with premium financing. For academic discussion let’s say the financing is 100% of the single premium US$300,000. Therefore upon death, the cash payout to wife is US$1,250,000 – 900000(mortgage) – 300000 (owe to the bank for premium financing) = US$50,000. So it can be seen that even with premium financing, the actual cash paid to wife is very little.
Major Infraction #4: The fact that only two years are provided for the family means breach of KPI 1 because the adviser fails to take into consideration the "duration of financial support required for each dependants." The time horizon required to support the dependents is actually around 20 years! The children is small and as the speaker said, the doctor’s wife had never work. Does anyone thinks she can work when the kids are so small? Even if she can work, is it really possible for her to earn a decent income? Come-on, anyone who has a spouse who is out of the labour force for so long will know the difficulty of trying to find proper work (no, I am not talking about selling tissue). Why did the doctor ends up with a policy that can only provide for two years for his family? The reason is because he was underinsured when he bought the 625% overpriced Universal Life. If he bought a term, he can easily afford say US$4,000,000 death cover whose premium is only US$5,959.10 annually and that can last his family for a truly long time. That’s legacy planning.
Major Infraction #5. Due to the wrong product being sold, the adviser beached KPI 1's Financial Objectives. The client clearly indicated that his objective is wealth preservation. Since the Universal Life cannot provide more than 2 years for his dependents, his wife has to liquidate his assets eventually and thus not able to preserve the estate value.
I have many clients who have been sold Universal Life. Often this comes with premium financing. These clients are not even Accredited Investors (high networth). So I urge the authority to do a 100% audit on all Universal Life policies sold to retail investors.
Note that I am not against Universal Life product itself. The product itself is neutral. How it is used is what I am against. It is just like a knife that can be used for good but also for bad.
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Some investors will be very happy as it shows a can-do go-getting spirit to bring in profits by whatever means necessary. With deteriorating quality of property loans, banks need all the cash they can get their hands on. At least the oil/gas/shipping industry should improve over the next year or so.
Anyway the bank will find it quite defensible in recommending this product if the documented client’s aim is simply to cover the outstanding mortgage & to provide the wife for 2 yrs living expenses. Is it the best solution? No. But is it fraudulent or harming the client in a significant manner? Again no. Even more so if client is AI & says he has other insurance & other financial assets to take care of other debts/expenses. Don’t forget about the example’s USD775K investments, USD600K clinic & USD125K cash. It will be a case of “No case” for MAS to investigate. Sad but true. Hard truth.
Wilfred Ling says
Given the low valuation of the clinic at US$600,000, it is likely the client is the sole keyman. Upon his demise, the clinic will be worth $0.