Benjamin Franklin famously proclaims – In this world, nothing can be said to be certain except for death and taxes. Since death is an absolute certainty, we should always ensure that we are sufficiently insured for that unfortunate event one day.
In today’s market, there are many types of insurance coverage. I am going to compare and analyse two common types of insurance: Life insurance vs Term insurance. There is a traditional saying “Buy term and invest the rest” How true is this statement? Let’s find out below:
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Life insurance is used to protect the life insured in the event of death. The premium that you paid is split into two portions. A small portion of your premium will go to the participating fund of the insurer and the remaining portion will be used to pay the insurance protection cost.
Life insurance is a small savings and high protection insurance. Because there is a savings element in life insurance, it will have a certain cash value which is declared yearly as reversionary bonus by the insurer.
The death benefit will then have a guaranteed portion which is the sum assured of the policy plus a non-guaranteed portion of reversionary bonus. The amount of reversionary bonus is based on the performance of participating fund. Life insurance, as the name imply, covers one for the whole life.
For new life insurers, the premium you need to pay is usually fixed, ranging from 5 years to 25 years. This means that you only need to pay for 5 years or up to 25 years and get life time cover.
Term insurance is a rather simple product. Term insurance is pure protection and nothing else. The entire premium paid goes towards insurance protection cost. Therefore, there is no cash value for term insurance. Term insurance can be used to cover for temporary needs. The premium payment term is the same as the coverage term. This means that you will need to pay the premium for the entire time you are covered.
Here is a summary of life insurance and term insurance:
|Features||Life Insurance||Term Insurance|
|Coverage Term||Life Time Death Coverage||Temporary Death Coverage|
|Objective||Savings + Protection||Pure Protection|
|Premium Term||5 to 25 years||Same as coverage term|
|Cash Value||Yes, depending on the performance of participating fund||No.|
Life vs Term
In order to compare these two forms of insurance, I have done an analysis by using Company A Life and Term insurance products. I prepared for coverage up to age 99, even though technically speaking life insurance covers up to 125 years old! The maximum coverage for term insurance is only up to 99 years old.
The analysis is done for a male, non-smoker, $100,000 death coverage, 85 years old life span. Because the life insurance premium payment terms and term insurance premium payment terms is not similar, we cannot compare by just looking at the face value of premium, the best way to measure the “return” of these two insurance is by using Internal Rate of Return (IRR). You can think it as yearly investment return.
There are a few outcomes we can glean from the chart above.
1. For most of the time, term insurance outperforms life insurance. One should buy term insurance as protection rather than using life insurance.
2. For newborn, buying a life insurance policy is actually better than buying term insurance.
3. Life insurance IRR decreases if you buy at a later age.
4. Best time to buy term insurance is at around 20 years of age.
Limitations of the Analysis
This analysis may not be perfect due to the following:
1. The data is based on Company A, it may not be the cheapest in the market.
2. The non-guaranteed portion of life insurance is assuming 3.25% projected participating fund return.
3. Usually life and term insurance come with riders, examples are critical illness and Total permanent disability rider. This analysis did not factor in the cost of these two riders.
4. The 85 years old life span is just an assumption. Different life span will change the result drastically. For example, if a person lives until 100 years old, IRR for term insurance is 0%.
Qualitatively assessing your insurance needs
This analysis is done purely based on quantitative analysis. Qualitative analysis as below should be considered before you decide which is the better plan for you:
1. Premium affordability is not considered in this case. The pros for life insurance is you can pay off the premium during the early age of life which most likely when you have the capability to pay the premium.
2. Buy term and invest the rest. This statement has two parts. “Buy term” analysis is done in this post. You will save some cost by buying term insurance. The second part of this statement is “Invest the rest”. You need to invest the rest. If you are a spender that spends the amount that you save from buying term insurance, then I would rather prefer you go get a life insurance.
3. Some life insurance allows you to add early critical illness that cover for life time. This type of life policy may be a better option if you are looking for protection against early stage critical illness.
Disclaimer, this analysis is not to advise you to surrender your life policy and switch to a term policy. Surrendering a life insurance policy always comes with a cost, you should check with your financial advisor before you make any decision.
Alternatively, you can drop me an email at firstname.lastname@example.org. I am happy to help you review your existing policies.