Sunday, November 6, 2011

Insurance a crucial building block

With markets swinging about as they do these days, it is natural for some investors to focus on spotting winners and try to pick the perfect entry and exit points. But growing your wealth is more than just a function of maximising stock returns in the shortest time possible. Managing outflows, especially unexpected ones, and steady wealth accumulation over the long term, are equally important to the planning and pursuit of any significant financial goal.

The increased market volatility that we are experiencing is reason for many investors to fret over their portfolios. Yet, while prudent management of these monies is essential, it would be a mistake to overlook a more basic building block for growing wealth. As much as you would hate to see the value of your portfolio fall by 20 per cent, the hospital bill resulting from an unexpected major illness or the loss of income due to an accident-caused disability can severely disrupt your financial goals.

For instance, you may have to liquidate your investments to pay for treatment and other basic needs. This is why it is critical to ensure that you have some basic insurance in place, which will allow you to continue working towards your investment goals even if something catastrophic happens to you.

Strengthen the backline

A simple term policy is an affordable way to begin. Those in their 20s, who have just started work, may find this option most palatable as desired cover can be obtained inexpensively. For some, a term plan may act as a liability cancellation policy so that the family is not saddled with the burden of repaying the outstanding mortgage on the family home in the case of the policyholder's demise.

While term plans can be bought with additional cover for critical and terminal illnesses, conventional whole life policies provide greater flexibility, offering optional protection for eventualities like disability and loss of income. These additional covers, called riders, can be added and removed at will.

Whole life plans may be constructed so that payments are accelerated during your working life to allow you to enjoy premium-free cover after retirement. Perhaps, the biggest advantage that whole life plans have over term plans is that they can serve also as a tool for wealth accumulation. Part of the higher premiums collected in whole life plans are invested in the insurer's participation fund, resulting in steady returns that can be cashed out as needed.

Consumers should note that whole life policies are designed to accumulate value over the long-term, so the cost of surrendering the policy early, particularly in the first few years, is very high as premiums mostly go towards paying for the cost of insurance.

Sure and steady progress

There are insurance products that go further towards the goal of wealth accumulation. Endowment policies may not be new, but unlike the 30-year tenures of old, durations these days can be much shorter if you haven't the patience or if you have started your retirement planning late.

Endowment plans are gaining wider acceptance here as more Singaporeans realise the place of steady, low-risk investments when it comes to their retirement savings. In deciding on an endowment plan, it is usually helpful to link it to an objective, which will help determine what the most appropriate tenure is. For example, a 25-year-old executive may find a 10-year plan appropriate if he is planning to use the payout to help pay for a condominium at age 35.

For investors who prefer the convenience of an all-in-one solution, investment-linked policies cover both wealth protection and accumulation needs. You get to decide the balance between protection and investment, and you get more say about how your money is invested. Potential returns are higher, as you may choose to invest in unit trusts that adopt a more aggressive stance than the insurer's typically conservative participation fund. But along with that is a higher chance of incurring losses should your investment strategy prove unsound or unbalanced.

Pass it on

Finally, insurance can help in legacy planning. A universal life plan is a single premium policy that can help you pass on wealth to your children, with a guaranteed rate of return on the money invested. If you plan to leave S$3 million to your children, you can take out a universal life plan with a sum assured of S$3 million for a fraction of the amount. The sum assured of the universal life plan is guaranteed, so you can be assured that your children will receive the bequest you intended for them even if you pass on early.

If you choose to manage and invest your funds on your own instead of buying a universal life plan, there is a risk that your bequest to your loved ones will fall short of the S$3 million you intended for them, as the amount will be dependent on the market value of your investments when the bequest is made.

There is no denying the allure of taking a punt on the market, but neglect not the basic foundations of financial planning. Insurance is a crucial building block in achieving your financial goals and with recent innovations, it can even offer solutions for more advanced needs.

Shrikant Bhat is head of wealth management at Citibank Singapore.

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