The Life Insurance Association, Singapore (LIA Singapore) recently announced that caps of illustrative investment returns used in policy illustrations for participating (par) policies (SGD) will be lowered by the life insurance industry here, effective 1 July 2021.

Caps of illustrative investment returns for par policies — what’s changed
Before 1 July 2021 From 1 July 2021
Upper illustration rate Capped at 4.75% p.a. Capped at 4.25% p.a.
Lower illustration rate* Capped at 3.25% p.a. Capped at 3.00% p.a.

*The lower illustration rate must be at least 1.25% p.a. below the upper illustration rate.

 

Wait, what?! Whoa, hold your horses there, buddy. There’s no need to panic — these upper and lower illustration rates are for illustrative purposes only and will not affect the actual returns of existing and future par policies. It’s just a gauge.

Here’s a couple of reasons why LIA Singapore decided to revise these caps downwards:

  • The sustained low interest rate environment (sigh, Covid-19)
  • Singapore Government Securities and US Treasures yields experienced a sharp drop last year (the Singapore Government 10-year bond’s interest rates fell 0.99% to 1.48% as of 31 May 2021, from 2.47% in end-2016)

Some insurers, such as Prudential and AXA, have also cut bonuses ahead of the announcement. However, it’s actually a prudent move for the life insurance industry at a time like this — we’ll explain further in this article.

 

What are par policies?

Before we dive deeper, let’s talk about par policies, especially for the benefit of those who are totally new to this concept.

A participating (par) policy is termed as such because it means in addition to receiving protection, you’ll also be participating in the profit of the insurance company’s participating fund. The premiums you pay will be put together with other par policyholders, and you’ll be able to reap the profits of the par fund.

Hence, your insurance benefit illustration will comprise both guaranteed and non-guaranteed benefits (i.e. bonuses and cash dividends), of which the latter is tied to the performance of the par fund. Other factors that could also impact your non-guaranteed benefits include claims by fellow policyholders and the fund’s expense ratio (costs incurred to manage the par fund).

Insurers usually declare these non-guaranteed bonuses annually and policyholders will be notified. Keep in mind that you probably won’t be able to enjoy these bonuses immediately. They are usually added to your sum assured or could be used to offset premiums. It really depends on the type of policy your insurer offers.

 

How about the par fund?

Now, you don’t need to do anything about the par fund as it will be handled by the insurer. However, you’re able to find out more about your insurer’s par fund such as the investment strategy, what it invests in and so on, in your policy’s product summary. Typically, the par fund invests in a range of assets such as bonds, stocks, REITs and so on. Like any investment fund out there, the investment mix may be tweaked or rebalanced from time to time, in order to maximise returns within acceptable volatility.

TL;DR

When reading the Par Fund Performance Update, you just need to refer to the following key indicators:

  • The annual investment performance of the insurer’s par fund
  • Which life insurers are consistent top performers (geometric return)
  • The life insurers that have a consistently low expense ratio

 

What about smoothing?

Smoothing, too, plays a role in determining policyholders’ non-guaranteed bonuses. Think about it as balancing out the years of good performance and the years of not-so-good performance. For example, in the years where the par fund investment performance exceeds expectations, the surplus could be kept in a reserve to pad up the declared bonuses in a year where the par fund didn’t do so well. By using this measured approach, the policy’s non-guaranteed returns could remain stable even during an economic downturn.

Do note that par policies are not the same as investment-linked insurance policies (ILPs). With ILPs, the returns are not smoothed and the cash value of the ILP depends heavily on the performance of the selected funds (policyholders can choose sub funds).

 

How has the insurance industry performed in the last 10 years?

Let’s take a look at the historical investment returns of the major life insurers over the last 10 years, from 2011 to 2020. Let’s first take a look at the yearly investment returns, and then see how it looks when the geometric average is used.

Why use the geometric average?

It’s most suitable for investment portfolios as it takes into account compounding (significant over a period of time) and correlation (returns/losses affect how much you can reinvest the following year), and hence is more accurate.

Unlike the arithmetic mean, where the sum of everything is divided by the number of years, the geometric mean multiplies these numbers together, to the power of the inverse of the total number of years.

It sounds cheem, but the calculations have all been done in the tables below!

 

Yearly par fund investment performance (2011 to 2020)

Based on insurers’ published reports

 

From the table above, here’s how the various insurers performed:

Insurer Number of times in Top 3 over 10-year period
AXA 6
AIA 5
Tokio Marine Life 4
GE Life 4
Prudential 4
NTUC Income 3
Aviva 2
Manulife 2

As you can see, based on the pure yearly par fund investment performance alone, AXA Life appeared 6 times in the “top three” over the decade. AIA has 5 “top three” spots, followed by the insurers that clinched 4 “top three” spots each: Great Eastern Life, Prudential and Tokio Marine Life Insurance Singapore. However, the funds’ investment performance tends to fluctuate quite a bit.

Let’s now look at the more accurate representation, in which the geometric average is used.

 

Yearly par fund investment performance – geometric mean (2011 to 2020)

Tokio Marine Life Insurance Singapore - par fund investment performance

Based on the data of insurers’ published reports

 

From the table above, here’s how the various insurers performed:

Insurer Number of times in Top 3 over 10-year period
AXA 8
Tokio Marine Life 5
Prudential 5
GE Life 4
NTUC Income 3
Aviva 2
Manulife 2
AIA 1

Phew, there is much more consistency in the numbers after smoothing with the geometric mean. At first glance, most of the figures now easily meet or exceed the projected illustrative returns we usually see on our policy document. Just to jog your memory, the illustrative cap before 1 July 2021 was a comfortable 4.75% p.a. (upper illustration rate) and 3.25% p.a. (lower illustration rate).

So in reality, based on these geometric average returns on the par fund, the actual investment returns are higher than the illustrated rate of return (remember, LIA Singapore said “These rates will not affect the actual returns of existing and future par policies”).

This time as well, AXA Life emerges on top, with 8 times in the “top three”. Tokio Marine Life Insurance Singapore and Prudential do well too, appearing in the “top three” 5 times in the past decade, followed by GE Life (4 times).

Let’s not forget about expense ratio

We also touched on expense ratio, the amount of money that goes towards managing the par fund and is taken from the returns of the par fund. The lower the expense ratio, the less is spent to manage the par funds, and there’ll be more profits to share between the policyholders who are all participating in the par fund.

Tokio Marine Life Insurance Singapore - par fund investment performance

Based on insurers’ published reports

 

Let’s take a look at how these major life insurers controlled the costs of managing their par funds from 2017 to 2019. 

NTUC Income did really well, with an expense ratio of below 1% p.a.; meanwhile AIA, Great Eastern Life and Tokio Marine Life Insurance Singapore had expense ratios that were below 2%. On the contrary, remember our “winner” of the par fund investment performance tables earlier? AXA Life has unfortunately spent the most on managing its par funds, with the highest expense ratios.

To sum up the above:

Insurer Top 3 for Geometric Mean? In Top 3 for Par Fund Investment Performance? Best 3 for Expense Ratio?
Tokio Marine Life Yes (5 out of 10) Yes (4 out of 10) Yes (3 out of 3)
GE Life Yes (4 out of 10) Yes (4 out of 10) Yes (1 out of 3)
AXA Yes (8 out of 10) Yes (6 out of 10) No (0 out of 3)
Prudential Yes (5 out of 10) Yes (4 out of 10) No (0 out of 3)
AIA No (1 out of 10) Yes (5 out of 10) Yes (2 out of 3)
NTUC Income No (3 out of 10) No (3 out of 10) Yes (3 out of 3)
Aviva No (2 out of 10) No (2 out of 10) No (0 out of 3)
Manulife No (2 out of 10) No (2 out of 10) No (0 out of 3)

Based on these results, Tokio Marine Life Insurance Singapore is the most consistent, and the only insurer to deliver positive results in all 3 categories.

 

Case study: Tokio Marine Life Insurance Singapore

We’ve picked Tokio Marine Life Insurance Singapore (TMLS) to do a case study on, seeing as how it’s performed consistently well in historical par fund investment performance, geometric average and expense ratio categories.

Tokio Marine Life Insurance Singapore - par fund investment performance

Source: Tokio Marine Life Insurance Singapore

 

Singling out TMLS and pitting it against LIA Singapore’s upper illustration rate cap over the past 10 years, the insurer has consistently exceeded expectations with only a slight “deficit” in 2011 (but this “deficit” is in fact, still a positive return of 5.14% p.a.). As you can see, in 2019 and 2020, TMLS not only exceeded the upper illustration rate cap dictated by LIA Singapore, but comfortably sailed over it by over 100%.

Based on the 10-year historical investment performance of TMLS, it’s pretty obvious that the illustrative rate cap as set out by LIA Singapore has no bearing on the actual returns and declared bonuses to policyholders — it merely serves as a guide, or a benchmark, for policyholders to visualise how much they could be getting in the future.

Tokio Marine Life Insurance Singapore - par fund investment performance

Based on insurers’ published reports

 

Going back to expense ratio, TMLS’ is really low, showing prudence in managing the costs of its par fund. In fact, its expense ratio is less than the industry average, and easily puts it in the Top 3 of major life insurers in Singapore.

All in all, TMLS has maintained a strong track record, even showing steadfastness in managing the investment returns of its par fund — considering how 2020 bore the brunt of Covid-19’s financial impact — to achieve positive returns every year.

 

So why the need to revise the illustrative investment return caps down?

You’re probably now wondering why LIA Singapore has to revise the illustrative rate caps down. Based on the figures above, it seems more than achievable for the major life insurers to meet or even exceed these illustrative rate caps.

Let’s imagine you work in sales. Every month, you have sales targets to meet. You’re good at your job, and you consistently meet or exceed these sales targets each month.

If your boss keeps revising the sales targets upwards, you have to work harder and harder each month, and during months where you took long leave or fell sick, it would look like you’re performing below expectations (but you’re still bringing in a lot of sales revenue). However, if your boss is understanding, he might revise the sales targets down when he knows that the market isn’t doing well.

Similar to this scenario, the one setting the expectation is LIA Singapore, but the real “bosses” who are doing the appraisals are us, the policyholders.

Thus, in light of the recent low interest rate environment, LIA Singapore has decided to exercise prudence and revise the illustrative rate caps downwards to manage policyholders’ expectations.

Even though it’s mostly psychological, don’t you feel sian if the insurer projects super-high illustrative rates but fails to meet them? It’s a classic case of over-promising and under-delivering.

Plus, revising the illustrative investment return caps down also serves to protect the interest of policyholders and the long-term sustainability of the fund. After all, with life insurance, you’re in it for the long haul. It’s better to have moderate sustained growth than volatile fluctuations — if you enjoy the latter, you’re better off investing in the stock market. Remember the saying, high risk, high return?

In addition, the life insurance industry reviews and declares the bonuses annually. This is another protective measure for policyholders — so that bonuses are “locked in” for that particular year, should the following year show poorer performance.


Where do we go from here?

As a policyholder, while the announcement by LIA Singapore initially seemed worrying, I later realised that it’s purely cosmetic (at least, to me).

Let’s look at it this way: The par fund’s actual investment returns in the future will depend on future economic conditions, actual asset class returns and asset allocation of the par fund. The fact that LIA Singapore revised the caps downwards is that it anticipates challenges in meeting the previous caps amidst this low interest rate environment.

The par fund manager is doing the best they can, but there are external factors we cannot control, like the ongoing global pandemic. It will be what it will be.

On our end, we need to stop harping on the illustrative numbers and recalibrate our expectations. To be honest, I always look at the lower illustrative returns cap — actually I’m happy as long as I break even.

Of course, if we expect lower returns, the breakeven point (where the surrender value of the policy equals the total premiums paid to date) will probably be even further in the future. But why are you looking at surrendering a policy that is supposed to last you throughout your life (life insurance leh)?! Surrendering your life insurance policy should be a last resort kind of situation.

Ultimately, the decision to buy life insurance shouldn’t lie solely on how much you can potentially “earn” (that’s why we have pure investment products), but rather, how well you are protected.

 

By Mr.Naz

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