Knowing the difference between term-life insurance and investment-linked insurance can protect your family’s future.
I’m an expat living in Hanoi, Australian by birth, with a wife and two young kids. I’ve been thinking about what would happen to my family if I were to pass away as I do not have enough money saved up to take care of them if something were to happen to me. My financial adviser mentioned I should consider either investment-linked or term-life insurance. I don’t know where to begin. What are the differences between the two, and how would they solve my problem?
As an expat you should be pretty familiar with the concept of insurance—a contract you sign with an insurance company that states the insurance company will pay you a specific sum of money if something where to happen to you, in return for paying the insurance company a specific sum each year. This is basically how term-life insurance works, and it’s a pretty straightforward, binary relationship where you pay an insurance company a certain sum each year, and in return the insurer will pay your family a fixed some as agreed upon in the contract if you die during the term you are insured for. If you die during your insured term, your family will receive an amount that is often far greater than the total amount that you paid to the insurer. If you don’t die during the time that you are insured, your policy expires and you receive nothing from the insurer. Either your family wins or the insurer wins. Simple.
Investment-linked insurance is far more complicated. It is essentially like a life insurance policy where you will be able to get some money back from the insurer if you don’t end up dying during the time you own the policy. This is because the money you pay to the insurer will be “invested,” usually into a pool of mutual funds.
This may sound enticing because on the surface it looks as though you will get the best of both worlds: a large lumpsum paid to your family by the insurer if you pass away; and if you don’t a nice savings pot at the end of the contract.
The problem is that the above can be misleading due to the following factors:
1) Cost of managing investment portfolio. The maximum amount you should ever pay annually for management of your investment portfolio is 2% of the portfolio’s value. Running an investment portfolio in an insurance-linked policy can often cost you up to 6% of the total value in the first few years, with many other hidden fees and terms, which makes it incredibly difficult to earn any return on your investment.
2) Untrained staff selling policies. Buying an investment-linked policy will mean that an investment portfolio will have to be put together and managed for you. Investment-linked salespeople often have no financial training or have been on a two-week sales training course. Managing an investment portfolio effectively requires a university degree and postgraduate studies.
3) It’s complicated. The terms and conditions can often consume more than 20 pages. Some of the most complicated financial contracts I’ve ever seen have been insurance-linked policies.
4) Premiums are usually higher than straight term-life. Insurers put a premium on your annual payments for the benefit of cashing in your policy before you pass away because they lose out on that extra bit of revenue as each policyholder survives.
5) It’s risky. With straight term-life insurance the risk rests with the insurer. You might only pay USD200 to the insurer and pass away early into your contract, which could lead to your family being paid USD1 million, for example. With an investment-linked product, the risk lies with you and there are no guarantees of what you might get in return. Everything depends on the performance of the investment portfolio.
What is the best option to consider? Most of the time, it is more appropriate to own your investment and insurance policies separately. Owning a straight term-life policy is easy to understand, very affordable, if you are healthy, and will be of great reward to your family if you pass away prematurely. There are a number of great providers that issue policies to expats globally.
Have your investments managed in separate accounts where you can manage your own portfolio through multitudes of online brokerages and platforms that exist globally, or hire a professional portfolio manager. It might seem inconvenient, but you will save loads of money, hassle and have far more assets in the long run.
BIO: Sven Roering is a Managing Partner at Tenzing Pacific Investment Management. He holds an Economics Degree from Rhodes University in South Africa, and is a candidate in the Chartered Financial Analyst (CFA) program, having successfully completed level 1 and is currently working towards the level 2 exam.