Monday, August 25, 2008

A fair reduction in yield

If you invest $5,000 for 30 years to earn a yield of 5%, you will receive $332,000 on the end of the period. This is an attractive investment, if the average inflation rate during this period is less than 3%.

If you invest in a life insurance product, you are likely to get an estimated yield of about 2.5%, giving $220,000 at the end of the period. The reduction of 2.5% in yield works out to $112,000 or 34% of the maturity sum of $332,000.

The actual cost of the life insurance protection is estimated to be 5% of the maturity sum. The remaining 29% in charges goes to pay commission to the agent and the expenses and profit of the insurance company.

I consider the reduction of 34% in maturity sum or 2.5% in yield to be too high and that the life insurance policy gives a poor deal to consumers.

A fair deduction should be 20% of the maturity sum, instead of 34%. This is used to provide the cost of insurance protection (5%) and the expenses (15%) for marketing and administration.

A reduction of 20% in the maturity sum over 30 years amounts to a reduction in yield of 1.4%. In the above example, the policyholder will get a return of $266,000 instead of $220,000.

Lesson: if the reduction in yield is less than 1.5%, the policy is giving a fair return (as it includes the cost of life insurance protection). If the reduction in yield is more than 1.5%, the policy is giving a poor deal to the consumer.

Joke: statements of motor accidents

> The pedestrian had no idea which way to run as I ran over him.

> I saw a slow moving, sad faced old gentleman as he bounced off the roof of my car.

> The indirect cause of the accident was a little guy in a small car with a big mouth.