How Participating Funds of Insurance Policies Work
The concept of insurance works on that of risk pooling. Premiums collected go into a common pool and are used to make payouts to claimants. The insurer manages this pool and will invest it to grow the size of the pool.
Holders of participating whole life or endowment policies are entitled to a share of the investment returns from this pool – we call this pool the participating fund or par fund. The returns are added to the value of individual policy holders every year via an annual bonus. Once this bonus has been declared, it is guaranteed. There is also a terminal (or surrender) bonus which will be given when there is a claim or when the policy is surrended.
An insurer might also have a few par fund for different classes of products.
In the past, the returns from these par funds are like a black box. No one (except the insurer) knows how they perform and the only clue you have is the annual statements you recieve which tell you how much annual bonus you have been given.
However since March this year, MAS has stipulated that insurers have to make known the performance of their par funds for the last three years in the benefits illustration. The expense ratio and asset allocation of the par funds also needs to be reflected.
A comparison of the performance and expense ratio of the par funds from three different insurance company reveals the following information:
Performance (% returns)
A : 2005 – 1.7%, 2006 – 5.9%, 2007 – 5%
B: 2005 – 13.2%, 2006 – 15.5%, 2007 – 12.3%
C: 2005 – 4.95%, 2006 – 8.39%, 2007 – 11.0%
Expense Ratio (percentage of the fund value that is spent on expenses)
A: 2005 – 0.08%, 2006 – 0.09%, 2007 – 0.09%
B: 2005 – 0.03%, 2006 – 0.02%, 2007 – 0.03%
C: 2005 – 0.23%, 2006 – 0.26%, 2007 – 0.31%
Clearly, there is a big difference in the performance of the different par funds.
If you look at the benefits illustration of an insurance policy now, it now shows your projected returns using two different levels of estimates for the returns of the par funds. For example, they might show projection based on 3.75%pa and 5.25% pa. This is a good thing as it will be clearer to the consumer that the returns are not guaranteed and also helps prevents mis-selling by the few over enthusiastic insurance agents.
Note that the returns of the par funds is not the same as the return you get on your investment. You will have to calculate your own internal rate of return based on the premiums paid and surrender value.
For example, a 5.25% projected returns of the par fund might show a guaranteed return of $50k and a non-guaranteed return of $15k for you. Your own annualised returns might be around 2-4%.
If the par fund performs better than 5.25%, your returns will be higher. And vice versa.
All these changes will help consumers better understand what they are purchasing when they buy an insurance policy. This is a step in the right direction.
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