Financial literacy is such a big thing now and everyone has a responsibility to up theirs. But the biggest responsibility for driving higher levels of literacy should start with the government, the financial media, financial people in the know, and qualified financial advisors and companies purveying financial products and services.
Sadly, the insurance industry isn’t doing much to address the complexities and misconceptions of their products. The most commonly sold level term life insurance policy is a fine example of this.
A level term (LT) policy fixes the insurance premium for the coverage period. For example, if you’re covered for RM100,000, the monthly premiums might be fixed at RM100 throughout the policy’s coverage. Contrast this to the less common and even more basic yearly renewable term (YRT) policy with annually inflating premiums. Under the same coverage of RM100,000, monthly premiums for the YRT might be only RM10 and very gradually rising to perhaps RM100 monthly or higher after maybe 20 years when incomes could well have grown high enough to afford that.
Actually whatever policy you choose is not going to make a lot of difference to the “insurance cost” which has been calculated by actuarial scientists. The LT just invests what effectively is the short term over-collection of premiums above the insurance cost to guarantee fixed premiums. Hence, an LT is just a YRT with investments. There’s no free lunch. You don’t get a discount buying one over the other because either you invest on your own or the insurer does it for you.
The LT is a terribly crazy idea for other reasons. It’s as crazy as, in the case of renting a home, leveling your rental. Say normal rentals are RM1,000 a month, the same home under a hypothetical levelling arrangement might cost RM10,000 a month to rent. Apart from the obvious that 10k is ludicrously unaffordable, there is also an impact on lifestyle choices: you can rent a range of homes from the mundane to the fancy by not fixing rent at 10k if you’ve already decided to spend that amount.
The analogy is direr in insurance because insurance is about giving financial support under unforeseen circumstances rather than a lifestyle product. Going back to our hypothetical policy, rechanneling that same RM100 monthly under an LT to a YRT might raise the sum assured from RM100k to RM1 million. People have to buy insurance with the mindset of providing for calamities tomorrow rather than for guaranteed fixed premiums in 5, 10 or 20 years, the longer you stretch coverage, the bigger the premium differences between YRT and LT are going to be. If you died of a disease tomorrow, touch wood, for the same RM100 premium, I’m guessing your family wouldn’t prefer the comfort of a fixed premium under a RM100,000 cover over the security of RM1m.
The other point is that investing on your own to provide for future cost of living inflation including insurance gives you more flexibility and visibility than investing through either an LT (because remember the insurer invests to guarantee fixed premiums) or an investment-linked policy. Insurance is always a consumption item and never savings or investment. If nothing happens to you, the premiums are considered spent for a good cause. This begs the question: why is life insurance one of the only few consumer products around using investing to hedge for future price rises? Why not bananas or fridges or clothing or education? Not even motor or travel insurance has the levelling element.
One reason for the prevalence of leveling term policies is that this is one of the only ways agents can make a living and through them, one of the only ways insurers can distribute. To a great extent LTs are made more expensive because of exorbitant agency commissions. However, times are a-changin. This is not to diss agents because the plight of agents who do good work are always highlighted by insurers. But this is to state that technology can bring distribution costs of commissionless YRTs sharply down, shifting focus more to the plight of consumers and their needs.
I’m also willing to bet that Bank Negara should be getting quite antsy right now over their long-ago target of 75% national coverage by 2020. We are now at just under 40%. The last time I checked, it’s 2019 and we are nowhere near targets. At the same time figures coming out of LIAM (Life Insurance Association of Malaysia) show that sums assured average at under RM50k, way below what LIAM itself believes to be adequate of 2-3x that figure. I believe one way to move forward with mass coverage is to take a lesson from low-cost airlines to go no-frills and sell the very affordable basic yearly renewable term policy.