If you've lived in Asia for a while, chances are good that either you or someone you know has been offered the chance to purchase a life insurance savings scheme. Sold by independent financial advisors, armies of commissioned insurance agents, bank branches, and other financial institutions; insurance-linked savings and investment schemes seem like the Herbalife of finance. Many local insurance products are heavily marketed by "agents" who have varying degrees of training and professionalism. Attracted by limited employment qualifications and lucrative commissions, the agents pitch their friends and acquaintances in ways that mirror multi-level marketing schemes.
In Thailand, glossy marketing brochures endorsed by agents, who are often friends and relatives, seem to offer attractive savings rates, tax deductions on premiums paid, and enhanced life insurance coverage. At first glance, these products look like a pretty good deal for someone who is serious about saving for the future and protecting their family. A closer look, however, shows this may not be the case for everyone.
First Impressions Can Be Deceiving
Provided they are bought and sold in an informed manner, many insurance products meet the legitimate needs of individuals and families. Insurance products are complex, however, which means consumers often don't understand what they are buying. This complexity, coupled with ill-informed consumers and the lack of a strong regulator, can lead to predatory sales practices.
Recently, we looked at one particular product sold by a Thai bank that required the investor to commit to paying THB 80,000 per year for a period of 10 years. In return, they received a life insurance product with an insurance value of THB 400,000 that is in force for a period of 15 years. The product has the following features:
- 15-year term insurance product
- Face value of THB 400,000
- Premiums: THB 80,000 per year for a period of 10 years; no premiums in the remaining five years
- Death benefit: The beneficiary receives 100% of the face value if the insured dies in years 1-3; 140% of face value if death occurs in year 4, 180% in years 5-6, and 200% in years 7-15
- Interest credited: The policy holder receives interest on the face value of THB 400,000 based on the following schedule: 3% for years 1-5, 4% for years 6-10, and 5% for years 11-15
- At the end of 15 years, the policy holder receives 185% of the face value or THB 740,000, in addition to the interest that has been paid
If this sounds complicated, it is. Most people just focus on the interest paid, which is higher than the interest being paid on bank deposits today, and on the THB 740,000 that is paid out at the end. The life insurance is a bonus that appears to pay out multiples of the original insured amount if the insured happens to die at the right time. Based on this information, many people conclude that the product is a good deal. But first impressions can be deceiving.
Not Much Life Insurance Value
You are getting very little insurance value for your THB 80,000 per year in premiums. Generally, the annual premiums for a 15-year term policy will only be a fraction of one percent of the policy's face value. This is less than THB 4,000 for a THB 400,000 policy. The insurance company can easily offload the mortality risk for a fraction of the THB 80,000 premium, and after some administrative expenses use the remaining funds as it sees fit. Of course, like a whole life insurance policy, the insurance company is crediting interest to your account as compensation. Unlike whole life insurance, which is meant to be permanent and ultimately self-funding, this policy terminates after 15 years. It is not permanent insurance.
The point is that the product is not really sold (or bought) on the basis of hedging mortality risk. There are cheaper and more effective ways to do this. After five years of premiums, you have already paid in THB 400,000 to the policy. After 10 years of premiums, you have paid in THB 800,000. At that point, the payout of two times face value (or THB 800,000) if the insured happens to die in years 7-15 doesn't look so much like your beneficiaries have won the lottery since you've already self-funded the payout. Presumably, if you had the ability to self-insure there would be no need to pay the insurance company for the privilege. Clearly, this product is designed primarily as a savings vehicle.
Savings Rate Not as Good as It Appears
With interest rates that exceed deposit rates and a step-up in rates over the life of the product, it seems that this insurance product must be a good deal. If you hold for the full 15 years, at first glance it looks like you are averaging 4% based on the rate schedule. Additionally, you are being paid interest on the THB 400,000 face value, rather than your "deposit" of THB 80,000.
There are several problems with this, however. First, you are paying in THB 800,000 over 10 years, but only receiving 185% of the face value (THB 740,000) at the end of the 15-year period. The 185%, which at first looks like a bonus, is actually less than your total premiums paid.
Second, while you are receiving interest on THB 400,000 in year one when you've only deposited THB 80,000, you are still receiving interest on THB 400,000 in year 10 after you have deposited THB 800,000 (THB 80,000 in premiums over 10 years).
To calculate your actual annual rate of return, you need to calculate an internal rate of return (NYSE:IRR) like in the table below:
Return on Investment (Units: THB '000)
*Failure to hold the product or pay required premiums results in disadvantageous payout schedules with annualized returns significantly less than 2.59%.
It turns out that if you hold the product over the entire 15-year period, your annual rate of return would only be 2.59%-far below the 4% return you assumed at first glance.
This leads to the next problem. To get that 2.59% annualized return, you have to hold the product for 15 years (and the insured needs to still be alive). On some money market investments, Thai asset management companies currently offer returns on cash of more than 2.5% tax-free with no lock-in period. Maybe a return of 2.59% over a period of 15 years doesn't look like such a bargain, especially given where we are in the global interest rate cycle.
Thai Tax Deduction Can Change the Math
In the case above, the person didn't qualify for a deduction of the premiums against their Thai taxes. For some working expats who pay Thai tax and are in an upper marginal tax bracket, the tax deduction can change the math. Consider the following example. If you are already making full allowable contributions to tax saving vehicles such as Thai Retirement Mutual Funds (RMFs) and Long-Term Equity Funds (LTFs), and you could reasonably expect to earn THB 5.2 million or more each year for the next 10 years, you could shield up to THB 100,000 in additional funds in an insurance policy and receive a Thai tax savings of 35% of the premium paid each year. In that case, the IRR in our previous example would rise to 8.52%. However, given the high annual salary and the length of time required, this return may apply to only a very small percentage of working expats. U.S. expats would need to carefully consider whether it would still make sense due to the additional U.S. tax that may be due, as well as the reporting requirements.
Good Deal for the Insurance Company
Basically, this product is a great deal for the insurance company. There is very little mortality risk to hedge, since the premium payments pretty much fund any death payment paid. The slight mismatch is easily and cheaply offloaded. The biggest benefit is that the insurance company gets to use your funds for 15 years while paying you well below market for the privilege. They can then use those funds to invest in higher-yielding investments, earning a relatively low-risk profit.
It Pays to Do Your Homework
Insurance products can be complicated. Marketing typically highlights benefits that may not tell the whole story. For investors who can't deduct the premiums against their taxes or are in the lower tax brackets, locking up funds at below-market rates for 15 years may not make sense. The next time you are tempted by a product that you may not fully understand, take the time to analyze it carefully to ensure it is suitable for your situation.
About Creveling & Creveling Private Wealth Advisory
Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information visit crevelingandcreveling.com.