Managing personal risks

A working person faces the following risks:

a) premature death

b) serious illness and disability

c) unemployment

d) insufficient income during retirement

The chance of (a) and (b) occurring during the working life is quite low, perhaps less than 5%. By getting bad advice from insurance agents, they spend too much of their savings to insure against these risk.

Most people (i.e. 95%) are likely to face the risk of (c) and (d). This risk can be best managed through personal savings. The savings should be invested to earn a good rate of return and can be withdrawn without penalty, e.g. through a low cost investment fund.  The personal savings can be used to cover cash flow needs during a temporary period of unemployment, without the need to depend on borrowings which incur a high interest burden. If the savings are invested prudently, they will provide an adequate amount for retirement.

Many investment products offer a poor yield of 2% per annum. By investing on their own in a low cost investment fund, they can get a much higher yield, for example, 5% per annum. The difference in yield is taken away in distribution cost and other charges by the financial institution.

Here is the difference in the accumulated amount at the end of 35 years from a monthly saving of $500.

Interest     Accumulated     %
rate             savings
2%           $306,000     100%
3%           $374,000     122%
4%           $460,000     155%
5%          $569,000      186%

Many people invest their hard earned savings in a life insurance policy to earn a net yield of 2% per annum. If they invest on their own in a low cost investment fund, they may be able to earn a higher yield, which could potentially give them 86% more.

They only need to spend 5% of their savings to buy a low cost decreasing term insurance. If this is taken off $569,000, they will still get a net balance of $540,000, which is still much higher than $306,000. They will accumulate sufficient savings in 20 years - so the insurance becomes less essential.

As an alternative, they can also buy a personal accident insurance for $300,000 at a premium of about $200 a year. Most of the risk of premature death is caused by accident.

Summary: the key priority is to have adequate savings (say 15% to 20% of your earnings, in addition to CPF) and to invest it in a low cost insurance fund to earn an adequate rate of return. Spend not more than 5% of your savings on term or personal accident insurance.

Tan Kin Lian