At times insurance documents are like online terms and conditions –
something unpleasant that we have to get through, by hook or by crook.
More often than not, we end up with glazed eyes and and a dull expression before resignedly making the inevitable conclusion to just proceed without reading.
Much like this:
Yet some of the most important pieces of information lie within those daunting stacks of policy papers, and in this article we drill down to address the Table of Deductions.
This is only important if you care about where your premiums go and how much returns you potentially can get off the policy!
One of more boring (yet important) tables in any Participating policy
Every participating policy (One that allows you to partake in the investment gains and losses of the insurer) will come with a Table of Deductions, with a sample shown below.
Typically it would be explained under the perils of “do not surrender your policy early, else you wont get as much returns”.
Yet there is so much more information that can/should be gleaned from this table. Grab a strong cup of coffee and lets start.
Making sense of it – as easy as 1,2,3
We break it down into 3 columns to focus on:
Column 1: Total Premium Paid To-Date
This shows you the amount of all the premiums you have paid at the end of each policy year. For this example, the yearly premium is $11,800 and payable for 25 years (nothing else needs to be paid after that).
After 10 policy years, the total premium paid is $118,000 (10 X $11,800).
Column 2: Value of Premiums Paid To-date
We use the illustrative return rate of 4.75% in this case.
This column tells you how much your premiums paid would be worth, assuming they were growing at a rate of 4.75% per annum on a compounded basis.
This would be your returns if 100% of your premiums were growing at 4.75% per annum, but insurance policies are not fixed deposits!
Column 3: Effect of Deductions To-date
Because insurance policies are not fixed deposits (policies provide coverage), there are costs associated, which would be deducted out of the premiums paid.
What this column shows is the cumulative amount that would be deducted from your premium returns, applied to a 4.75% per annum growth rate.
To put all 3 columns together, let us consider the 2nd horizontal line.
Column 1 – Total Premiums Paid would have been $23,600 ($11,800 X 2 Years)
Column 2 – Total worth of those Premiums would be $25,308 ($11,800*1.0475*1.0475 + $11,800*1.0475)
Column 3 – Total amount “lost” due to deductions being compounded @ 4.75% pa is $25,308
Hence the surrender value of this policy after the end of 2 years is 0.
Something’s sorely missing
Personally I think there is a missing column that would be so much more revealing and useful for the consumer.
Instead of applying the investment rates (3.25% or 4.75%) to compound the effect of deductions, it would be far more illuminating to show exactly how much is being deducted from the policy each year.
Perhaps it might turn some people off from ever buying par plans, but it sure beats having disgruntled policy holders many years down the road.
After some mathematical kungfu, we came up with the actual amount deducted from the yearly premium for this particular plan:
Then it becomes clear that for the first and second year, all of the premiums are deducted (hence not generating any returns). This deduction continues all the way till year 9, where $2,364 is deducted. In all, a total of $60,920 is deducted from the policy, out of an amount of $106,200 paid.
We can understand why this information isn’t revealed.
Why understand it at all?
At the heart of the matter, we see a lot of data lumping. This doesn’t necessarily paint the correct picture for the consumer, especially one that has been set on the idea of getting returns from his or her insurance policy.
By understanding this table properly, you will see that a certain portion of your premiums are used for anything other than investing for returns (protection/mortality costs, distribution fees etc).
Walk into any par plan (Whole Life, Endowment) with the correct mindset: Protection comes first, Investment returns are the secondary consideration.
Appreciation and thanks to Money Law, who suggested that we cover this topic. You can follow him on his facebook page here, as he regularly shares his thoughts on protection and investing.
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.
Are there insurance conundrums that are bugging you? Let us know in the comments section below, and we will get on the case!