Explain how a participating whole life policy builds cash value and how the insurer declares bonuses.
A whole life illustration can show a policy growing to far more than you paid in, and most of that growth usually comes from bonuses. Some of the numbers on the page are promised in the contract. Others are projections that depend on decisions nobody has made yet. If you can't tell them apart, you can end up buying a policy for figures that may never arrive.
Most traditional whole life and endowment plans in Singapore are participating policies. A participating policy shares in the profits of a pool of money the insurer keeps for similar policies, called the participating fund or par fund. Your premiums, after the cost of cover and expenses, go into that fund alongside everyone else's. The insurer invests the par fund, and its assets can include government and corporate bonds, equities, property and cash. The fund pays claims and surrenders, and it holds reserves to meet the guarantees in every policy.
When the fund earns more than it needs for guarantees and costs, part of the surplus is paid out to policyholders as bonuses. The insurer's shareholders may also take a share of what is distributed, within limits set under MAS rules. How the insurer manages the fund and decides bonuses is set out in documents it publishes and in the product summary.
Your policy's growth therefore depends on three things you don't control: how well the par fund's investments perform, what the insurer's claims and expenses cost, and how much the insurer decides to distribute.
Par policies typically use two kinds of bonus, and the difference between them matters more than the amount.
A reversionary bonus is usually added once a year as an increase in the sum assured. Once it is declared and added, it normally cannot be taken away, and it forms part of what the policy pays on death or at maturity. If you surrender the policy early, a reversionary bonus usually pays only its cash value, which is less than its face amount.
A terminal bonus is paid only when the policy ends through a claim, maturity or surrender. It is not added along the way. Until it is paid, the insurer can raise it, cut it or remove it depending on how the fund performs. In many policies the terminal bonus makes up a large part of the projected value in later years, and it is also the part least certain to arrive.
Some policies pay cash bonuses instead. You can take these or leave them with the insurer to accumulate at a non-guaranteed rate. The product summary states which bonuses a policy uses.
On a policy you already hold, reversionary bonuses already declared are part of its value. Future bonuses shown in an illustration, both reversionary and terminal, are projections.
Insurers also practise smoothing: they hold back some surplus in strong years and draw on it in weak years, so bonuses change gradually. This has two effects. Bonuses lag the markets in both directions, so good runs and bad runs both show up slowly. And when bonuses are cut, the cut tends to reflect several years of weaker returns at once, which can shock policyholders who have only ever seen steady numbers.
MAS requires insurers to regularly update existing par policyholders on how the par fund is performing and the outlook for future bonus payouts. Before you buy, ask the insurer how its par fund has performed and what bonuses it has declared in past years. A history of steady bonuses is useful information about how the fund has been run, and it carries no promise about the years ahead.
Every par illustration splits its values into guaranteed and non-guaranteed. Guaranteed values are what the contract promises if you keep paying premiums, as long as the insurer stays solvent. They are usually well below the illustrated totals, especially in the early decades. Everything above the guaranteed line depends on future fund performance and bonus decisions that have not been made yet, including future reversionary bonuses and the terminal bonus. The illustration shows these non-guaranteed values at two assumed rates of return, which Lesson 3.2, "Read a whole life illustration from first page to last", explains.
Judge a par policy first on its guaranteed values. If it suits you on those, anything extra is a bonus in both senses. If it only makes sense with the projected bonuses included, you are relying on returns nobody has promised you.
Ryan, an insurance adviser, pitched Jun Hao a new whole life plan: S$4,000 a year for 30 years, with a S$200,000 sum assured (an invented example). The table showed that at age 65 the total surrender value was well above all the premiums paid, and the death benefit had grown well past S$200,000. Ryan said the growth came from bonuses.
Jun Hao asked where the bonuses came from. Ryan said the insurer declares them every year based on how the fund does. That is true, but it leaves out most of what Jun Hao needed to judge the table.
Jun Hao circled three things on it: the guaranteed death benefit of S$200,000, the guaranteed surrender value at age 65, and the share of the age-65 total that came from terminal bonus. Jun Hao already held a whole life policy, so they also looked up its latest bonus statement to see how much reversionary bonus had already been declared on it.
The same checks work on any par policy you are offered or already hold:
Check the product summary for which bonus types the policy uses: reversionary, terminal or cash. Before buying, ask the insurer how the par fund has performed and what bonuses it has declared in past years. On the illustration, find the guaranteed values, including the death benefit and the surrender value. Work out how much of the projected total comes from terminal bonus. For a policy you already hold, check the latest bonus statement for reversionary bonus already declared. Sort the values already declared from the ones only projected. Judge the policy first on its guaranteed values, and treat anything above them as unpromised.
You'll do the same with an illustration of your own: find each bonus type it uses, and sort what's already declared from what's only projected.
Find the bonus types in a whole life illustration. For each one, write whether it has already been declared or is only projected.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).