By Genevieve Cua

ASIA’s brisk pace of wealth creation and accumulation is revving up demand for — as well as supply of — large insurance policies commonly called universal life plans.

But some industry participants are concerned that keen competition and lucrative earnings are spurring bankers to sell such plans to the mass affluent segment as well, who may not understand the policies’ risks. The mass affluent are defined as those with net investible assets of at least S$200,000.

Worse still, some of the less wealthy may actually tap premium financing for the plan. Some banks even dangle interest-only financing for the early years of a plan. But this process of borrowing to finance the premiums adds leverage and could magnify risks.

In any case, the market is seen to be so robust that HSBC, for one, is launching a Singapore dollar universal life plan, which it says is the first here. The Sing dollar Jade Global Select Universal Life has a minimum sum assured of S$1.2 million. Among other insurers, Great Eastern Life said it is monitoring interest in a Sing dollar plan.

Modest crediting rate

The crediting rate of a local currency plan, however, will be relatively modest in line with the very low interest rates here. Jade’s minimum Sing dollar crediting rate is one per cent, compared to roughly 3 per cent for a US dollar plan. HSBC’s new plan, however, offers an option for policyholders to lock in guaranteed annual rates for limited periods of one year (3.5 per cent); three years (2.8 per cent); and five years (3 per cent).

Marcus Teo, HSBC acting head for retail banking and wealth management, says that the bank had received ‘very strong’ interest in a Sing dollar plan, particularly with the strong appreciation of the Sing dollar. ‘The strength and stability of the Singapore dollar and economy gives investors confidence that their wealth is secured in a currency with a positive growth outlook in the long term.’

The Jade series, underwritten by HSBC Insurance, was launched in 2009 and has generated more than US$1 billion in sales regionally. Weighted premiums rose 35 per cent in 2010 and the firm expects business from Jade to more than double this year.

First, some basics. A universal life plan is similar to the traditional whole life plan, but it is non-participating — that is, premiums are not invested into a life fund. Instead, premiums are projected to grow at a specified interest or crediting rate.

Flexibility advantage

What makes these plans appealing to the wealthy is that they are flexible, and offer jumbo death benefits which lend themselves to estate planning. For instance, you can pay premiums in a single lump sum or a limited-pay period. You can borrow money to pay the premium. The policy can also be structured for you to withdraw the cash value at regular intervals.

Clients are also said to prefer the stability of a whole life plan with a cash value, rather than a so-called ‘variable’ life plan where the investment portion can be any portfolio of the client’s choice. There are more than a handful of insurers in the universal life space, including Transamerica, AIA, HSBC and Prudential. Companies such as Friends Provident offer variable life plans.

There are of course quite a few caveats to universal life plans. One is that the interest rate may be too low to sustain the plan as the policyholder ages. The current crediting rate for a US dollar plan ranges between four and 4.75 per cent. The projected cash values and even the death benefit will depend on the crediting rate being sustained.

Here is an example: A 54-year-old who enters a US$1 million policy may find that the policy lapses at the 25th year assuming a minimum crediting rate of 3 per cent.

Says Mark Smallwood, Deutsche Bank managing director and head of wealth management solutions Asia Pacific: ‘The danger is that, as with any investment, there is a risk that the projected results are not attained. The risk of a universal life policy is that the crediting rate is not sufficient over time to accumulate value; the cost of insurance rises and eats into the crediting amount. If the policy fails to accumulate at the right pace, one reaches a point when the cost of insurance and the cost of the policy creates negative growth in the cash value, which creates an exponential collapse in the cash value. People are then expected to top up the premiums to maintain the policy over time.’

No-lapse guarantees

To increase a plan’s appeal, insurers here offer a ‘no-lapse guarantee’ feature where for additional premiums, the policy can be guaranteed to maintain its death benefit until a specified age, usually 100. Premiums will cost substantially more. Based on a quote by GE Life, for example, a 50-year-old man will pay a single premium of US$123,131, based on preferred life, for a death benefit of US$500,000, without a no-lapse guarantee.

A plan with a no-lapse guarantee will cost US$44,300 more, or a single premium of US$167,431.

Odd Haavik, managing director of Charles Monat Associates, says: ‘With interest rates at historically low levels, long term returns have to reflect this, and so the no-lapse guarantee has become far more expensive …

‘With or without the no-lapse guarantee, a universal life policy is still a tremendously powerful risk management tool offering a very high level of transparency with respect to costs and benefits. Without the no-lapse guarantee, it is incumbent upon the adviser to be diligent in policy reviews so that clients are aware of any crediting rate changes and what the effects are on the account and cash surrender values.’

Leverage through premium financing could also accelerate the drain on the policy especially if crediting rates are reduced. Foreign currency adds yet another layer of risk.

Dependent on rates

As a Singapore-based client, you could be borrowing in US dollars to finance a US dollar policy. A stronger US dollar will magnify your liability. While the financing rate is seen to be attractive at the moment — US dollar Sibor plus one percentage point — the rate could rise particularly in periods of financial stress.

If you are scrutinising a universal life plan, do look into costs as well. Distribution costs are generally roughly 10 per cent of a single premium, but there are annual expense and insurance charges which could come to about one per cent a year.

One of the major concerns is that of a mismatch between the crediting rate and the US 10-year Treasury rate currently at 2.8 per cent. Of course, not all the funds will be invested in Treasury bonds. Some will be invested in high grade corporate bonds.

Says Mr Haavik: ‘From an insured’s point of view, the issue is mainly with the insurer’s ability to meet its obligations to their clients — mainly to pay claims. The key is to select an insurance company that has built up a strong general investment account over decades and can weather relatively long periods of low interest rates … A newer entrant may be forced to drop crediting rates sooner and more often, even re-price the product in order to weather this period.’

This article was first published in The Business Times.

We shall highlight some common behavioural bias among CPF members and the measures undertaken by the CPF board to minimise its impact.

Bounded Rationality Bounded rationality is the idea that in decision making, rationality of individuals is limited by the information they have. Most people have a strong tendency to underestimate their post-retirement needs. According to the Singapore department of statistics in 2010, the life expectancy of an average retiring Singaporean male is 83.  The figure is expected to rise further due to advances in medical technologies. For example, a young male graduate spending $1,200 monthly and wishing to retire at age 55, will need a lump sum in excess of $860,000 just to ensure self sufficiency for day to day expenses. This is without taking into account increased healthcare and hospitalisation costs in retirement years.

Most Singaporeans generally cannot envision themselves living past age 80.  By making individual savings compulsory, CPF is able to kill two birds with one stone, namely addressing the problem of a lack of foresight, as well as a lack of discipline.

Hyperbolic Discounting

The idea of hyperbolic discounting states that given two similar rewards, humans show a preference for one that arrives sooner rather than later.
The CPF Minimum Sum Scheme addresses people’s tendency to value short-term usage of CPF monies (E.g. investments, housing or education) significantly over their longer-term retirement needs.
Locking up part of the individual’s CPF savings until his retirement age and then disbursing the monies as lifelong annuity stream constrains the individual’s ability to over-consume in his early years of retirement.

Loss Aversion
Loss aversion refers to people’s tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains. For employed CPF members, the employee contribution is deducted directly from their income before they are paid monthly; this reduces the feeling of loss among CPF members.
The Medishield programme is also a good example of CPF’s application of loss aversion principles.  By making medishield an automatic enrolment and an opt-out scheme, an individual will tend to feel he is losing something if he were to opt out; this encourages CPF members to stick to the default option of staying with medishield.

Can behaviourial economics save us from ourselves?

Status Quo Bias.

Status Quo Bias suggests that people tend not to change an established behaviour unless the incentive to change is compelling.
Many Singaporeans are unaware of the mechanics of medical insurance, term & mortgage insurance and whole life annuities. If these individual decisions are to be left to CPF members, the complexity of these financial products would probably result in CPF members postponing their decisions and being severely underinsured.

As a result, the CPF board has designed these programs such that they are on an opt-out basis. Examples include medishield, dependent protection scheme, home protection scheme and CPF Life. Even for the all important decision of a lifelong annuity scheme, CPF life, the default option for retiring CPF members is also set as the “Balanced” plan, which is deemed to be the preferred option.

Self Serving BiasSelf Serving Bias is the tendency to claim more responsibility for successes than failures.  The CPF Investment scheme has allowed members to invest in stocks, unit trusts, property funds and even gold due to the varying investment appetites of CPF members. This has encouraged savvy members who want to take charge of their investment returns to actively manage their CPF monies so they can attribute investment returns to their individual skills rather than earning a stable fixed rate of interest in the CPF account.

Statistics paint a different picture though. As of FY2010, 86% of CPF members who use their OA for investments are unable to make net realised profits in excess of the OA interest rate of 2.5%.  In addition, 49% of CPF members who invested lost monies in their investments,

In order to curb the self serving bias which encourages CPF members to invest for the sake of investing, the CPF board have indicated that only amounts in excess of $20,000 in Ordinary Account and/or more than $40,000 in their Special Account can be used for investments (As of Sep 2011).  It is likely that this limit will be further increased in the future if the trend of investment losses suffered by CPF members continue.

Conclusion
Does the ends justify the means? Most Singaporeans suffer from information overload as well as attention scarcity, leaving decision making to CPF members can result in choice paradox and can have unintended negative consequences. Substituting the invisible hand of the market with the hand of the government, may not be a bad idea after all, even for the most crucial life decisions such as retirement planning.

Written by Gary Tay

Portfolio diversification is widely recognised as a vital technique for reducing risks that are part and parcel of investing. Indeed, it is probably the most important ingredient for reaching one’s long-term financial goals while keeping risk to a minimum. Financial markets are notoriously known for their vulnerability to swings but it is these very cycles that present profitable investment opportunities. Yet even the savviest investors are hard-pressed to predict these crests and valleys accurately all the time, much less pick winners and losers with absolute precision.

Maximise profit, minimise risk

Diversification recognises this limitation in our divination abilities and presents a realistic and practical approach to help the investor maximise his or her returns.

The basic concept is simple: Spread your money across a variety of financial instruments, industries and geographies, so that when a market shock occurs, you do not risk losing your entire wealth in one fell swoop. The reverse is also true: When markets are booming, casting your net wide increases the chance of owning the winners.

Underlying diversification is the fact that different assets do not react identically to a single event. For an investor, it is important that in any part of the market cycle, some assets do well so as to offset the weak performance of others. As an example, during the recent financial crisis, while most financial assets fell, gold defied gravity and proved a big winner for many investors.

More is not always better — watch for correlation risk

There are many ways of achieving diversification. For many, a diversified portfolio means owning a variety of stocks in different industries, geographies and currencies. But superior diversification is often achieved through spreading your investments across different asset classes as well.

The underlying aim is to own a combination of investments which are as uncorrelated with each other as possible. Simply owning a large number of different investments may not achieve the aims of diversification if the assets react largely in a similar manner to adverse events.

For example, if your portfolio consisted only of property equities, cooling measures by the government may cause the portfolio to drop in value. This could be mitigated if you also owned bank stocks. However, these too may be hit by the cooling measures as dampened demand for mortgages weakens bank lending business. To further diversify, you may want to include stocks in less related sectors such as manufacturing and technology.

Better yet, diversifying into another asset class, such as bonds, can further mitigate your portfolio’s sensitivity to market swings. Bonds and stocks, for instance, generally move in opposite directions. If your investments are balanced across both asset types, negative movements in one may be offset by positive results in the other.

Indeed, studies have shown that asset class choice matter more than individual security selection — about 70 per cent of a portfolio’s performance is derived from getting into the right asset class at the right time.

One size does not fit all — and not all the time

So how then should you determine the optimal blend of investments in your portfolio?

Taking a long-term view, first work out what your financial aims are, considering the time horizon and the level of risk and volatility that you are comfortable with.

By and large, a young investor may prefer a more aggressive portfolio that bears more risk as compared with a retiree who is more concerned about wealth preservation and maintaining a steady income.

Market circumstances must also be considered and as they change, so must your portfolio be reviewed and rebalanced. Consider engaging expert help from bankers and financial advisers, who, with access to more tools and up-to-date market information, can help you with a periodic review of the performance of your portfolio and make appropriate adjustments in asset allocations with a view to meeting your investment objectives.

This exercise is vital as changes in the market as well as individual circumstances can impact the outlook of your portfolio. Wealth managers have a formalised process to provide this service as part of their advisory offering.

One convenient way to achieve a diversified portfolio is to invest via unit trusts. Each fund is diversified across a multitude of securities within the fund’s investment theme. Some even offer exposure to different asset classes, such as a combination of stocks and bonds. For more sophisticated investors, specialised instruments such as hedge funds and exchange-traded funds, offer additional ways to diversify their investments.

As with diets and many things in life, balance is necessary for the health and longevity of your investment portfolio. Regardless of how attractive that “sure win” investment looks, too much of a good thing can turn a portfolio bad quite quickly. Instead, take advantage of the variety in the buffet of global assets and put together a plate that best suits your financial goals and risk appetite.

Shrikant Bhat is head of wealth management at Citibank Singapore Limited.