Many industry players view this ‘free’ 1st year coverage as a marketing gimmick. Many other industries run similar campaigns. For example, electronic stores may offer a free DVD player for purchase of a LCD TV. The intention of promotion is to get the attention and interest of consumers and to sell them other products. An important to answer is – Have the products that have been proposed meet the needs of the client?

The high lapse rate signal that the policy owner do not view that coverage as a need. The strong economic numbers would make financial hardship an unlikely reason for the phenomenon. Many promoters of similar ‘free’ campaigns would tell you “If you don’t like it, you can just cancel it’. Only those that have been approached know if similar tactics have been used.

I had the thought that most of the policy owners would have conveniently continued with the policy after the 1st year as it would be ‘troublesome’ to cancel. After all, it is a common tactic that telcos and tele-marketers use to get consumer to sign up plans. To my surprise, this has not been the case. However, no lapse numbers was published. We do not know it is 20% or 80%.

There is no free lunch in this world. If you are offered something for ‘free’, most probably, you will be paying through other means.

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1. Horror Story – Bank tries to sell 10 year structured deposit to a 90 year old
2. Landbanking Firm’s High Return?
3. Minibond,High Note,Pinnacle Note,Jubilee Note Protest at Speakers Corner at Hong Lim
4. How a RM mis-sell endowment
5. What kind of portfolio is this?

In an Straits Times article on 26th June 2010, Excuse me, are you an independent adviser?, the issue of volume bonus was raised by Lorna Tan. Volume bonus are extra bonus for hitting certain sales quota or renewals. Volume bonus may be paid in advance for the commitment to deliver certain amount of sales in a stipulated time. Volume bonus can sway the firm and the adviser to push certain products.

A ‘fee-only’ advisory firm  was quoted as treating its independent status seriously by rebating commission. The question to ask is whether ALL commissions are rebated. While a ‘fee only’ model may be a good idea, it does not remove the chances of unethical conduct totally. As the income is derived from fees, an unethical adviser may try to position the client into a fee paying setup when a commission-based solution may be more suitable.

Different advisory models have its pros and cons. Some models are inherently handicapped by the range of possible solutions while others may be abused by the adviser. At the end of the day, the honesty of the adviser plays a key role in the journey to one’s financial goals.

Related posts:

1. Would you buy it yourself?
2. Windfall For Jumping Ship
3. Horror Story – Bank tries to sell 10 year structured deposit to a 90 year old
4. The Rich Don’t Deserve To Get Conned
5. Damaging Advisers

The Minimum Sum Scheme

Depending on your birthday, the corresponding  Minimum Sum (MS) will be different for different ages. This MS would provide a monthly payout that would last approximately 20 years. The prevailing Minimum Sum (MS) is $117,000.

The Draw Down Age (DDA), ie when you can start receiving the payout, is different for different ages.

Table 1 MMS DDA

Assuming a CPF member aged 55 having the MS of $117,000 fully in cash, he can start receiving a monthly payout of $1,040 for about 20 years. The interest rate is assumed to be 4% per annum.

Payout under CPF LIFE

Certain CPF members will automatically be included under the CPF LIFE scheme while others can opt to join in. Table 2 below indicates the various scenarios.

Table 2 CPF LIFE Eligibility

Upon joining CPF LIFE, depending on the age, gender and plan selected, a certain percentage of the RA savings will be transferred to the CPF LIFE account as premium for the annuity. The Table 3 shows some figures derived from the CPF LIFE Payout Estimator. As the LIFE Plus and LIFE Income plan deducts ALL of the RA savings as premium, only LIFE Basic and LIFE Balanced plan is shown.

Table 3 CPF LIFE Premium Rate

In addition to the Annuity Premium deducted upon joining CPF LIFE, the extra 1% interest earned first $60,000 in the SMRA savings and and top ups (if any) will also be deducted as Annuity premium around 2 months before DDA in the same ratio as the initial deduction when first joining CPF LIFE.

Payout will start with whatever amount that is left in the RA account after deducting the annuity premium plus earned interest. Payout from the CPF LIFE Annuity will begin after the monies in the RA account exhausted. Figure 1 shows how the  payout is derived from the RA account and the CPF LIFE Annuity.

Figure 1 CPF LIFE Annuity Payout Graph

The Table 4 shows the annuity payout starting age for the different ages. Only 3 of the plans; LIFE Basic, LIFE Balanced and LIFE Plus provides a refund of any unused premium. LIFE Income does not provide any refund of annuity premium.

Table 4 Annuity Payout Start Age

Interest gain from the annuity premiums is paid into the Lifelong Income Fund and pooled together with interest earned from the annuity premium from other CPF LIFE participants to fund the life long payout. Meaning to say, participants will potentially loose the interest if he/she pass away too early. However, the participant will gain more than his/her rightful share of the interest by living beyond a certain age. The Table 5 illustrates the estimated  amount of interest lost at different passing age for a 55 year old make with $117K in the RA. Note that for LIFE Income, the ‘loss’ includes the annuity premium as this plan does not provide any refund of unused premium. Calculations do not take into account the extra 1% interest for the first $60K from the SMRA account nor any top-ups. Negative figures indicate a ‘gain’ for the participant. Also note that the red region does not indicate the exact age of end of premium refund as the table only illustrate ages in 5 year increment. The calculations are from my own understanding of the scheme and is very much a rough estimation. Readers should be mindful that there could be errors in my assumptions and/or calculations.

Table 5 Estimated Interest Lost

The following table shows the estimated break-even age for the various plans in order to get back all the principal and rightful interest for a 55 year old male with $117K in the RA account with a 3.75% annual interest . As the monthly payout is different, different plans will give a different break-even age. Dying before the break-even age will result in a ‘loss’. Again, the extra 1% interest from the first $60K from the SMRA account is not taken into account. Figures shown are rounded to the nearest whole number.

Table 6 CPF LIFE Estimated Break-even Age

Compared to the MMS payout, CPF LIFE plans (other than LIFE Income) give a lower monthly amount but provides a lifelong income, unlike the MMS which lasts around 20 years. For MMS, there won’t be any ‘loss’ of principal or interest as any balance in the Minimum Sum will be refunded to the beneficiaries. CPF LIFE participants face a possible  ‘loss’ of principal and/or interest as only the unused annuity premium is refunded for 3 plans. CPF Income does not refund any annuity premium at all. CPF LIFE participants take on this risk of loss in exchange for a lifelong income. However, as the interest rates and mortality rate are not guaranteed and subject to change, any changes to could impact the payout amount.

As there are too many permutations to the payouts depending on gender, age, interest and RA amount, the above comparison for CPF LIFE are done for a 55 year old Male with $117,000 in the RA account. Interest rate is assumed to be 3.75% pa. Also, limited information relating to how the payout calculations are arrived at is clouding the understanding of CPF LIFE.

Related posts:

1. Changes to CPF LIFE
2. CPF LIFE vs Commercial Annuity
3. CPF Interest Rates for SMRA Accounts
4. CPF Interest Rates for SMRA Accounts for Jan 09 – Mar 09
5. Misleading advert on transferring CPF OA to SA?

There have been no official word on the reason for the plan withdrawal. My personal take is that:

• The low interest rate environment has made it difficult and risky to offer high guaranteed cash values. Low bond yields is a bane to the insurer. This is 1 of the reasons quoted for the controversial restructuring of NTUC’s bonus structure in 2008.
• The uncertain investment climate is no help for policies with high guaranteed values. Investment performance going forward may be choppy. Low bond yields have compounded the problem.
• The insurer is under the ‘curse’ of being the only insurer with 100% record of meeting bonus projections. Any insurer would give an arm and leg to have this distinction. Laden with the task of meeting the bonus projections for the legacy of old policies, newer ones may have to come with lower bonus projections. We are already seeing more participating plans (from other companies) with lower bonus projections.

I certainly wish to be wrong and see TM AsiaLife come out with even better endowment plans. But I do not harbour high hopes. Lets keep our fingers crossed.

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When I first got to know they are going to place advertisement in the papers a couple of days ago, I was worried that they will place fancifully colored full page advertisements that cost tens of thousands of dollars. I was pleasantly surprised to find their their advert taking just slightly more than a quarter page in simple black and white.

This insurer rarely places advertisements in the media. In my opinion, this is good for policy-holders as marketing cost is lowered, thus translating into better value for policy-holders. When coming up with premiums, insurance companies has to take into account mortality and morbidity rates, investment income, expenses and a profit margin. Advertisement is a form of expense. A lower expense would normally point to a lower premium, if not, a bigger amount for investment. Investment return is an unknown future occurrence. Expenses is a known current outflow. If the outflow is lower, this would naturally mean a lower risk for the insurer and thus the policy-holder. However, a lower expense would not mean lower premiums as the insurance company may use different mortality/morbidity tables, take different investment return estimates or go for higher profit margin. A competitive market with balanced distribution channels would mitigate the chances of having too high a profit margin.

In my opinion, the responsibilities of the insurance company is not to generate publicity but to provide the promised coverage and a reasonable return in the case of participating plans. But without publicity, consumers may not even know that such companies exist. Many man-in-the-street would never bother to check out such companies. The responsibility then rest with advisers who then have to recommend the products with superior product features and not the ones with superior commission structures. This is sadly, easier said than done.

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Most serious investors would be interested in the factors listed above. However, 2 factors are often overlooked -

1. Avoiding forced liquidation at the wrong time
2. Protecting those investments from creditors

Scenario 1 could happen if the investor were to pass away during a market downturn, like now. Assets that are force-sold due to probate process could fetch just half their price.

Scenario 2 could be a concern for business owners or members of the management. Their family members could be easily affected as assets are taken away by creditors. Even insurance policies with cash values could be taken away.

One way of solving these 2 problems is through the setting up of a Trust. The idea behind this is that the asset is given away in a Trust and creditors have no right to something that does not belong to the debtor. Setting up a Trust after getting into debtor-creditor issues is not going to work as Trust must not be set up fraudulently.

However, one of the main concerns of setting up Trust is the Settlor’s (the person who set up the Trust) lost of control over the assets. Settlors may also worry about the Trustee’s ability to manage the assets efficiently. Using professional Corporate Trustees is usually not cheap.

There is actually a way of Trust setup that may offers creditor protection without lost of control. I will give more info in due time.

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The criteria are as follows:

• Male
• Single premium of $67,000 at age 55
• First payout at age 65

CPF LIFE Plans

Commercial Annuity Plan

CPF LIFE Plan VS Commercial Annuity

Note: Assuming that the commercial annuity plan and the CPF LIFE plans grows at the assumed interest rate

It has to be noted that the commercial annuity has no guaranteed min growth rate after the 2.5% interest rate during the deferred period (ie, the 10 years from age 55 to 65). In CPF LIFE’s case, there is a min interest rate of 3.5% for up to the first $60,000 in the SMRA and 2.5% in excess of that.

Assuming that the schemes perform as projected in their various assumptions, the commercial annuity may be competitive if it grows at 2%/pa. If it grows at 0.5%, it is unlikely to match any of the CPF LIFE plans in monthly payout. The bequest amount at age 70 is lower than the Balanced and Basic plan. However, I am assuming death occurs at the start of age 70. The amount will be lower if death occurs at the end of age 70.

Having said the above, not enough information has been released by CPF Board regarding the min payouts and bequests amount at different ages for the various CPF LIFE plans.

The pros and cons of the leading commercial annuity over CPF LIFE is as follows:

Pros

• The minimum payout can be established yearly as the bonus is guaranteed once declared. Eg, A bonus of $20.55 declared at age 65 will be guaranteed and the guaranteed monthly amount is $421.90. The monthly payout in CPF LIFE may decrease depending on the actual interest rate and mortality rate. Payout under CPF LIFE is not guaranteed.
• CPF Life only allows a maximum amount equivalent to the Minimum Sum to be committed to the scheme. Commercial annuity has much higher limits (if any).
• If bought using cash, it can be liquidated easily without much loss to the principal amount.  Surrender option is unlikely to be available to CPF LIFE.
• There is no chance of losing the majority of the principal in the case of early death as the commercial plan will refund the balance of the unused amount. In LIFE Income plan, an early death will result in a ‘loss’.

Cons

• There is no min interest rate after the deferred period (if applicable). The CPF LIFE plans has a min interest rate.
• The starting min monthly payout is likely to be lower than even the lowest amount in CPF Basic plan.
• Commercial annuity holders are exposed to the credit risks of the provider.

Related posts:

1. Changes to CPF LIFE
2. CPF LIFE – How It Works
3. CPF Interest Rates for SMRA Accounts
4. CPF Interest Rates for SMRA Accounts for Jan 09 – Mar 09
5. Misleading advert on transferring CPF OA to SA?

Some things to take note of:

• The payout may not stay the same throughout the payout period as it depends on the floating interest rate and also the mortality rate. This means that there may be a situation of getting a higher payout for some years followed by lower payouts the next.
• The illustrated amount left for beneficiaries is for someone who passes away at age 70. There is no illustration for a longer lifespan. The bequest will get smaller as the lifespan increases.
• The payout is not linked to inflation. That means, assuming no changes to the payout, the actual purchasing power will actually decrease over the years due to inflation.

To get a better illustration of the scheme, some of the following data can be released

• As there is a min guaranteed interest rate of 3.5% for the 1st $60,000 in the OA and SMRA and 2.5% for amounts in excess of $60,000, a min monthly payout can be shown for the worst case scenario (in the case of interest rates. It may be hard to assume worst case scenarios for the mortality rate). This may help to avoid the situation of people having too rosy an expectation.
• The bequest amount for other ages should be shown as well. A estimated age whereby the bequest will run out should also be shown.

Related posts:

1. CPF LIFE – How It Works
2. CPF LIFE vs Commercial Annuity
3. CPF Interest Rates for SMRA Accounts
4. CPF Interest Rates for SMRA Accounts for Jan 09 – Mar 09
5. Misleading advert on transferring CPF OA to SA?