The lowdown on universal life plans

There are many risks involved, especially if the plan is in a foreign currency.

Wed, Jul 20, 2011
The Business Times

By Genevieve Cua

ASIA’s brisk pace of wealth creation and accumulation is revving up demand for – as well as supply of – large insurance policies commonly called universal life plans.

But some industry participants are concerned that keen competition and lucrative earnings are spurring bankers to sell such plans to the mass affluent segment as well, who may not understand the policies’ risks. The mass affluent are defined as those with net investible assets of at least S$200,000.

Worse still, some of the less wealthy may actually tap premium financing for the plan. Some banks even dangle interest-only financing for the early years of a plan. But this process of borrowing to finance the premiums adds leverage and could magnify risks.

In any case, the market is seen to be so robust that HSBC, for one, is launching a Singapore dollar universal life plan, which it says is the first here. The Sing dollar Jade Global Select Universal Life has a minimum sum assured of S$1.2 million. Among other insurers, Great Eastern Life said it is monitoring interest in a Sing dollar plan.

Modest crediting rate

The crediting rate of a local currency plan, however, will be relatively modest in line with the very low interest rates here. Jade’s minimum Sing dollar crediting rate is one per cent, compared to roughly 3 per cent for a US dollar plan. HSBC’s new plan, however, offers an option for policyholders to lock in guaranteed annual rates for limited periods of one year (3.5 per cent); three years (2.8 per cent); and five years (3 per cent).

Marcus Teo, HSBC acting head for retail banking and wealth management, says that the bank had received ‘very strong’ interest in a Sing dollar plan, particularly with the strong appreciation of the Sing dollar. ‘The strength and stability of the Singapore dollar and economy gives investors confidence that their wealth is secured in a currency with a positive growth outlook in the long term.’

The Jade series, underwritten by HSBC Insurance, was launched in 2009 and has generated more than US$1 billion in sales regionally. Weighted premiums rose 35 per cent in 2010 and the firm expects business from Jade to more than double this year.

First, some basics. A universal life plan is similar to the traditional whole life plan, but it is non-participating – that is, premiums are not invested into a life fund. Instead, premiums are projected to grow at a specified interest or crediting rate.

Flexibility advantage

What makes these plans appealing to the wealthy is that they are flexible, and offer jumbo death benefits which lend themselves to estate planning. For instance, you can pay premiums in a single lump sum or a limited-pay period. You can borrow money to pay the premium. The policy can also be structured for you to withdraw the cash value at regular intervals.

Clients are also said to prefer the stability of a whole life plan with a cash value, rather than a so-called ‘variable’ life plan where the investment portion can be any portfolio of the client’s choice. There are more than a handful of insurers in the universal life space, including Transamerica, AIA, HSBC and Prudential. Companies such as Friends Provident offer variable life plans.

There are of course quite a few caveats to universal life plans. One is that the interest rate may be too low to sustain the plan as the policyholder ages. The current crediting rate for a US dollar plan ranges between four and 4.75 per cent. The projected cash values and even the death benefit will depend on the crediting rate being sustained.

Here is an example: A 54-year-old who enters a US$1 million policy may find that the policy lapses at the 25th year assuming a minimum crediting rate of 3 per cent.

Says Mark Smallwood, Deutsche Bank managing director and head of wealth management solutions Asia Pacific: ‘The danger is that, as with any investment, there is a risk that the projected results are not attained. The risk of a universal life policy is that the crediting rate is not sufficient over time to accumulate value; the cost of insurance rises and eats into the crediting amount. If the policy fails to accumulate at the right pace, one reaches a point when the cost of insurance and the cost of the policy creates negative growth in the cash value, which creates an exponential collapse in the cash value. People are then expected to top up the premiums to maintain the policy over time.’

No-lapse guarantees

To increase a plan’s appeal, insurers here offer a ‘no-lapse guarantee’ feature where for additional premiums, the policy can be guaranteed to maintain its death benefit until a specified age, usually 100. Premiums will cost substantially more. Based on a quote by GE Life, for example, a 50-year-old man will pay a single premium of US$123,131, based on preferred life, for a death benefit of US$500,000, without a no-lapse guarantee.

A plan with a no-lapse guarantee will cost US$44,300 more, or a single premium of US$167,431.

Odd Haavik, managing director of Charles Monat Associates, says: ‘With interest rates at historically low levels, long term returns have to reflect this, and so the no-lapse guarantee has become far more expensive . . .

‘With or without the no-lapse guarantee, a universal life policy is still a tremendously powerful risk management tool offering a very high level of transparency with respect to costs and benefits. Without the no-lapse guarantee, it is incumbent upon the adviser to be diligent in policy reviews so that clients are aware of any crediting rate changes and what the effects are on the account and cash surrender values.’

Leverage through premium financing could also accelerate the drain on the policy especially if crediting rates are reduced. Foreign currency adds yet another layer of risk.

Dependent on rates

As a Singapore-based client, you could be borrowing in US dollars to finance a US dollar policy. A stronger US dollar will magnify your liability. While the financing rate is seen to be attractive at the moment – US dollar Sibor plus one percentage point – the rate could rise particularly in periods of financial stress.

If you are scrutinising a universal life plan, do look into costs as well. Distribution costs are generally roughly 10 per cent of a single premium, but there are annual expense and insurance charges which could come to about one per cent a year.

One of the major concerns is that of a mismatch between the crediting rate and the US 10-year Treasury rate currently at 2.8 per cent. Of course, not all the funds will be invested in Treasury bonds. Some will be invested in high grade corporate bonds.

Says Mr Haavik: ‘From an insured’s point of view, the issue is mainly with the insurer’s ability to meet its obligations to their clients – mainly to pay claims. The key is to select an insurance company that has built up a strong general investment account over decades and can weather relatively long periods of low interest rates . . . A newer entrant may be forced to drop crediting rates sooner and more often, even re-price the product in order to weather this period.’

This article was first published in The Business Times. Link

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