Saturday, August 11, 2007

Insurance Policiy as a Savings Vehicle

Do you have problem saving up? Read this if you are one of those who have no discipline to save.

The saving tips that I am about to share with you is a Forced Saving Program through the use of insurance policy.

Life insurance as a useful savings vehicle can come in two form:
a) non-participating policy with cash value
b) participating policy

A non-participating policy refers to a life insurance policy that does not share in the profits of the insurer i.e. the policy-owners of such products are not entitled to any bonus payment by the insurer. Such products are also known as without profits policies. Only non-participating policies that acquire cash value has a savings element. Term insurance is also a non-participating policy but it is purely for death protection purpose and does not have savings element because it does not acquire cash value.

Participating policies, on the other hand, refer to life insurance products that share in the profits or surplus of the insurer. Such products are also known as with profits policies and the policy owners receive bonuses from the insurer. The bonuses are declared on an annual basis and are guaranteed once they have been declared. Participating policies acquire cash value too.

What is Cash Value? Cash value (also known as "Cash Surrender Value" or reserve) is the amount of money, before certain adjustments, that the policy owner will get in the event that he surrenders his policy to the insurer for cancellation. Cash value arises as a result of the level premium system adopted by insurers. During the early years of the policy, the premium paid covers more than the cost of insurance protection provided by the company because the risk that the insured will die is lower. In the later years of the policy, the same premium covers less than the cost for the insurance protection by the policy as the insured grows old and is more likely to die. The extra premium collected in the early years by the insurer is set aside partly to form the policy's cash value. As time goes on and premiums continue to be paid, the cash value grows.

A word of caution: Most of these policies don't start to build decent cash value until their 12th or 15th year. Usually, it will breakeven on the 10th year i.e. total premium paid = cash value accumulated. So if you surrender in the first five years or so, practically most of the money you put in will be down the drain. Hence, if you buy one, be prepared to pay into it for a very long haul to yield a reasonable return for your retirement. Otherwise, I think you should just forget about it.

Surplus from the participating policies is the amount by which the insurer's assets exceed its liabilities. Surplus usually arises from:
a) bonus loading on participating policies;
b) the profits made by the insurer from all classes of business

Returns from these policies are usually in the range of 3 to 5%.

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