If you find yourself confounded by life insurance, have we got good news!
Today, we demystify all the key components that make up a life insurance product. And this guide is so complete yet so simple to understand, that whether you’re a newbie or a complete pro, you’re bound to wish someone came up with this guide earlier.
Ready? Here goes.
Let’s start with 5 basic attributes shared by all life insurance policies:
1. Cost of Insurance (COI)
The Cost of Insurance is how much it costs for the insurer to insure you for a given amount. When your premiums are paid, any amount allocated from the premiums to paying the Cost of Insurance is “burned” (earned by the insurer).
Regardless of when you bought the policy, the Cost of Insurance increases as your age increases. Because the older you get, the higher your mortality rate is (the probability of death occurring). Therefore, it will cost more to be insured as you age.
2. Premiums Payable
Premiums Payable is how much you have to pay to keep the policy alive. When premiums are paid, parts of it are allocated to different items (E.g. Admin Fees, Commissions, Cost of Insurance, accumulating Cash Value).
It is interesting to note that even though the Cost of Insurance increases over time, the premiums you pay DO NOT necessarily increase. It all depends on how the schedule of payments is designed. And there are 3 types of payment schedules:
a. Amortized Payment
Amortized payment is the most common of payment schedules. A fixed amount is paid on a regular basis (monthly or yearly) to keep the policy alive. It is designed to provide predictability in payments.
At the beginning of the policy, Premiums Payable are higher than the Cost of Insurance. Whatever premiums that was overpaid at the start goes towards building a Cash Value for the policy. With time however, the Cost of Insurance will eventually overtake the Premiums Payable. At that point, some of the Cash Value will be used to pay the difference.
To think it in a simpler manner, you are overpaying (lending) at a younger age, then as you grow older, you are underpaying (getting back your return).
b. Bullet Payment (Aka Single premium OR once off payment)
Bullet payment schedule is where instead of having to pay your premiums on a regular recurring basis, the full amount is settled all at once before the start of the policy.
This type of payment schedule is common with MRTAs.
c. As Per Cost of Insurance
In this payment schedule, Premiums Payable tracks closely the cost of insurance. There is almost no overpayment or underpayment.
This type of payment can be seen in some of the newer products introduced by online insurance providers.
3. Insurance Cover
The Insurance Cover is the minimum amount of money you / your beneficiaries will get if the insurance policy is triggered. The amount can be higher if the accumulated Cash Value of the policy is more than the Insurance Cover.
There are two basic types of Insurance Cover:
a. Level Cover
With Level Cover, the amount of Insurance Cover remains the same throughout the term. (In some variants it can go higher. But never lower.).
Most life insurance policies are designed this way.
b. Reducing Cover
With Reducing Cover, the amount of Insurance Cover decreases over time till it reaches zero at maturity. Overall, while the Cost of Insurance may be cheaper with time, it comes at the cost of reducing Insurance Cover as time goes by.
4. Cash Value / Savings
Cash Value is the amount which you have accrued in your insurance policy when you start paying a higher premium than the Cost of Insurance. The Cash Value of your insurance could be used in several manners:
- Surrender Value (The amount you will get if you terminate your insurance early)
- Increase your Insurance Cover
- Used to pay off Premiums Payable
- Make withdrawals
Certain types of policies will build Cash Value faster (typically sold under the guise of Savings / Endowment Plans). Other types of policies do not build any Cash Value. Just keep in mind that any savings components would have already been priced into the premiums.
5. Bundled features / riders
This is the only attribute of a life insurance policy that is not quantifiable. Most life insurance products have an option to add on riders (additional trigger events apart from death for an insurance pay out). The most common rider is the 36 Critical Illness rider (includes diseases like cancer, heart attack and kidney failure).
Note that while different insurers may name the riders similarly (E.g. 36 Critical Illness Rider), not all riders are created equal. E.g. Some policies only 4th stage cancer is claimable, while others are claimable at 1st stage cancer. The devil is in the details with this one.
If you’ve read till this point, great! You should have gotten a grasp of how these 5 basic attributes make up any life insurance policy. In fact, you are now ready to pick apart and assess any life policies put before you, regardless of how much marketing treatment it has been given.
Speaking of marketing treatment… By now, you’d probably be wondering how the various products normally seen on the market today stack up against each other when measured by these attributes. In fact, how do some of the policies you may already own measure up?
That will be the subject of the 2nd part of this article, where we measure the 5 most commonly seen types of life insurance policies found in Malaysia.