Let’s not kid ourselves, the world of a 12-year-old is rough indeed.
And we need to give them credit where credit is due.
Imagine a world where you have to deal with nagging parents that are simultaneously worried yet hoping that you would grow up quickly.
A world where not having enough likes on each Instagram post is detrimental to your street cred.
And not to mention, the immense pressure that is PSLE. The one exam that arguably determines your whole future, as prophesied by many a tuition center. And that particular exam can stump many adults.
For example, try this on for size (without a calculator):
Jim bought some chocolates and gave half of it to Ken. Ken bought some sweets and gave half of it to Jim. Jim ate 12 sweets and Ken ate 18 chocolates. The ratio of Jim’s sweets to chocolates became 1:7 and the ratio of Ken’s sweets to chocolates became 1:4. How many sweets did Ken buy?
Whew. Glad I left that tumultuous period behind.
So with grudging respect, we have determined that many of our 12-year-old heroes actually hold the key to explaining why we (adults) are consistently disappointed with the endowment plans that we purchase.
With your kind permission, we first take a stab at examining why we love to hate endowments, especially those that we have already purchased.
Endowment Plans – A cursory (yet faulty) way to understand them
The perennial opener of many a roadshow insurance, the endowment plan (commonly known as Savings plan) is hugely popular as a first policy, as it panders to the fact that we actually *may* get to enjoy some returns on our premiums.
For the uninitiated, these are the points we (as the policy purchaser) focus on hearing/remembering throughout any presentation.
(N.B. We use a sample endowment plan from an unknown insurer for this illustration)
1. A projected 4.75% per annum investment return
How it is usually interpreted:
An upper limit of 4.75% per annum investment return is what the LIA (Life Insurance Association) allows to be used for illustration. Never mind the lower limit, we should really focus on the upside – Optimism is the spice of life, no?
2. Look! The average Investment Returns of past years are usually more than 4.75% already!
How it is usually interpreted:
There we have it! This plan’s investment returns are already higher than what the illustration says it might be. We’re being conservative in our estimate, and conservative is good.
3. By logical deduction, and putting points 1 and 2 together, my money should grow at least 4.75% per year. All this and I get some protection cover too. Where do I sign?
As they say, the rest is history.
Why we end up being disappointed
1. Not all the premiums paid are invested
In our example, the yearly premium paid by the policyholder is $3,759 for a total of 12 payments. But not all of that money is actually invested (and hence gaining a return), because a portion of it goes to:
– mortality / insurance charges (to cover the protection component of the plan)
– distribution charges (aka commissions, to pay our agent for their hard work)
2. Investment returns each year are not guaranteed
This paragraph is always present within your set of policy documents – but whether it registers on a conscious level is not guaranteed.
A low return in the early years can affect the overall return significantly, but we shall leave the calculations for a future article.
3. The big picture might not look as rosy
Check out the lower half of the picture:
What does an illustrated Yield to maturity (YTM) mean?
As highlighted earlier, not all your paid premiums go into the investment fund, tirelessly generating returns for you. A portion of it (we reveal later how much in this example) actually is unavailable / spent elsewhere, leaving a fraction of your premiums to be generating returns.
The illustrated YTM is the % growth assuming ALL of your premiums were used for generating returns.
So in this example, what it means is that this person’s total premiums ($45,102 over 12 years) are effectively growing at a rate of 3.74% per annum compounded, even though the investment returns may have been reported at 4.75% throughout this entire period.
Which leads us to the next question: How much of the total premiums paid are actually used for investment? By utilizing our not inconsiderable math/excel skills, we found that for this illustration, 88.2% of each yearly premium is invested.
Another way to look at it: 11.8% of the plan is used for protection/other charges, the rest (88.2%) of it fulfills its savings function.
How would a 12-Year-Old explain this disappointment to us?
Oddly enough, they would sum up our less than satisfactory experience in 10 words:
“Uncle / Aunty, why you never read (the material) carefully one?”
Adults of the world, unite!
That’s all there is to it. Read the material carefully, and seek clarification if you are unclear.
Simple enough to do, but hard to execute in practice.
In our haste to believe in the efficacy in Endowment plans, we could be idealizing them and misunderstanding several key points about the plan. Not to say these plans are bad or unsuitable per se, but you need to understand fully what you are getting into.
So the next time you consider just about any policy, remember to channel your inner 12-Year-Old first.
www.ClearlySurely.com aims to eradicate the knowledge gap between consumers and Life Insurance. Our Vision is that one day, every Man, Woman, and Child will be properly insured.
And for those still stuck on the maths question posed earlier, Ken bought 68 sweets. Just work it through again if you can’t get it. Email us at email@example.com if you really need the solution, we won’t judge you.