Poor return on a policy with regular payouts

A reader asked my advice on a life insurance policy that was bought a few years ago. It provided a cash payment every 5 years and projected the accumulation of the installments on a non-guaranteed interest rate of 5% per annum.

The benefit illustration showed the following:

a) The distribution cost, which is the amount taken from the savings to pay commission to the agent and other marketing expenses, amounted to $3,467 for the first 6 years, representing about 2 years of the premium. This will continue to increase for each year but at a lower pace. With two years of the savings taken away, the return on the policy is likely to be poor.

b) At the end of 20 years, the projected amount as follows:

guaranteed $40,300

non-guaranteed: $14,881 (assuming the coupons accumulate at 5% p.a.)

total $55,181 

c) It is better to be conservative and assume that the coupon will accumulate at 2.5% p.a. and take the non-guaranteed portion at half, i.e. $7,440. The projected amount at the end of 20 years will be $47,740, representing a  yield of 1.8% p.a. on the savings. This is a reduction of 3.4% from the projected yield of 5.25%. This reduction is excessive - this policy gives a poor return.

d) If the annual premium of $1,967 is invested to earn 5.25% p.a. the total accumulated savings at the end of 20 years would be $70,292. The projected payout (based on a more conservative estimate) is $47,740, representing a reduction of 32% (which is excessive).

The life insurance policy gives a poor return. But, If it is terminated now, the policyholder will still suffer a large loss. It will be difficult for me to advice whether to continue or terminate the policy at this time, as it depends on the  personal circumstances and priorities of the policyholder.

Tan Kin Lian