Effect of Deduction

The benefit illustration for a life insurance policy (i.e. whole life, endowment, critical illness) shows the projected surrender values based on an interest rate of 3.75% and 5.25%. The average of 4.5% represents, in my view, a fairly realistic projection of the future yield on the investment of a well diversified life insurance fund based on current economic conditions.

If you are getting this type of yield, it is important that the amount taken away from your savings should be modest, and not excessive. In my view, a reduction in yield (to cover the mortality and expenses) of 1.5% is acceptable, giving you a net yield of 3%. If you buy riders to cover other risks, the premiums are charged separately and do not affect the calculation for the basic policy.

I find that most benefit illustrations show a higher reduction in yield, due to high commission and high profit margin for the insurance company. The product is bad for consumers and should be avoided.

The reduction in yield is not shown in the benefit illustration. However, you can compute it by looking at two figures that are shown, namely the "effect of deduction" and the "value of accumulated premiums".

Based on the benchmark of 1.5% reduction in yield, the "effect of deduction" should not exceed the following percentage of the "value of accumulated premiums".

Premium payable for	Maximum deduction
10 years	8%
15 years	11.8%
20 years	15.6%
25 years	19.4%

For example, if you pay $X a year in premium and the value of premium after 20 years is $100,000, the "effect of deduction" should not exceed 15.6%,or $15.600. I have seen many examples where the effect of deduction could be twice of the fair amount, giving a poor yield to the policyholder.

Tip: If the "effect of deduction" is less than the above benchmark, the policy gives you a good value. If it exceeds the above benchmark by a small amount (say 5%), it is still acceptable. But do not accept any product where the "effect of deduction" is more higher. If you are earning so little (due to the low interest environment), do not allow the insurance company or the agent to take so much away from you.