Protection

The Case of Term vs Whole Life Insurance: Chapter 2 & 3


Article Author - Christopher Tan
By Christopher Tan
Jul 12, 2016

This article is part of The Case of Term vs Whole Life Insurance: A Comprehensive Consumer Guide e-book. The following chapters will be released shortly.

To read Prologue and Chapter 1 of the e-book: Click here


Chapter 2 - How Long Do We Need Insurance Coverage For?


Death/Total Permanent Disability (TPD) Coverage


Why does one buy insurance that pays upon death/TPD? For most people, the primary reason is to replace loss of income for the family and dependants when the income earner is no longer around. There are other secondary reasons why people buy this type of insurance but we will discuss that later in this chapter. For now, let’s focus on people whom buy insurance for the purpose of income replacement. For this same group of people, the following situations are when such insurance is not or no longer needed:


a. When there are no more dependants

There will come a time in our life when we have no more dependants or they have become independent of us. Such situations are when:

  1. Our children have all grown up and are working. Our parents are no longer around as they have predeceased us.
  2. We are single and our parents, whom were dependent on us, have predeceased us.
  3. Our children have all grown up and are working. Our spouse is working and can support himself/herself with his/her own income plus accumulated assets.

b. And when our earned income is no longer needed

There will also come a time in our life where we will no longer earn or need an income. Such situations are when:

  1. We have retired. During this stage of our life, we will be living off our retirement nest egg and our children if any, would be independent of us. If death occurs, there is no income to replace as we have already retired.
  2. We have sufficient assets to fund the family lifestyle, even upon our demise. Assets can come in the form of property investments, stocks and shares, business and so on and so forth.

Summary

So if we are buying insurance that pays upon death/TPD, for the purpose of replacing income loss, when we don’t have or no longer have dependants and when our earned income is no longer needed, there is no need for coverage. Our need for this kind of insurance is therefore temporary and not permanent.



Dread Disease/Critical Illness Coverage


Why does one buy insurance that pays upon diagnosis of a dread disease (a.k.a critical illness)? There are 2 primary reasons:

  1. To replace income loss as one might not be able to work due to illness
  2. To pay for the cost of alternative medicine and care that may not be covered by hospital plans

So if we are buying it for the purpose of replacing income loss, the following situations are when such dread disease insurance is not or no longer needed:


a. When there are no more dependants

There will come a time in our life when we have no more dependants or they have become independent of us. Such situations are when:

  1. Our children have all grown up and are working. Our parents are no longer around as they have predeceased us.
  2. We are single and our parents have predeceased us
  3. Our children have all grown up and are working. Our spouse is working and can support himself/herself with his/her own income plus accumulated assets

b. When our earned income is no longer needed

There will also come a time in our life where we will no longer earn or need an income. Such situations are when:

  1. We have retired. During this stage of our life, we will be living off our retirement nest egg and our children if any, would be independent of us. If death occurs, there is no income to replace as we have already retired.
  2. We have sufficient asset to fund the family lifestyle, even upon our demise. Assets can come in the form of property investments, stocks and shares, business and so on and so forth.

And if we are buying it for the purpose of paying for the cost of alternative medicine and care that may not be covered by hospital plans, we will likely need this dread disease insurance for as long as we want it. When we no longer want this option, then we don’t need this kind of insurance anymore.


Summary

So if we are buying insurance that pays upon diagnosis of a dread disease, for the purpose of replacing income loss, there will come a time when we will no longer need it. This is when we don’t have or no longer have dependants and when our earned income is no longer needed. Our need for this kind of insurance is therefore temporary and not permanent.

But if we are buying it for the purpose of paying for the cost of alternative medicine and care that may not be covered by hospital plans, we will need this kind of insurance for as long as we want it. Our need for this kind of insurance is permanent and not temporary. 



Some Other Reasons Why People Buy Insurance That Pays Upon Death and/or Diagnosis of a Dread Disease


  1. Paying off liabilities such as mortgage loans, car loan and other liabilities

    Most of us will have some liabilities such as mortgage loans or car loans. When we pass away, we would want to ensure that these liabilities can be fully taken care of, so that we do not leave behind financial burdens for our loved ones to undertake. The good thing about loans is that there is an end point to them. There will be a day when they will be fully repaid. So if we are buying insurance to allow our family to pay off these liabilities in the event of our unfortunate demise, there will come a time when we no longer need it, because the loans have been fully taken care of. Once again, our need for this kind of insurance is therefore temporary and not permanent.

  2. Ability to fund children’s education upon demise

    For those of us with children, we would have plans to accumulate towards funding their tertiary education. However, the concern is when death occurs, we may not have accumulated enough funds yet. Buying insurance to provide an immediate lump sum upon demise is useful. But if we survive till the time when the kids have graduated, such insurance coverage is no longer necessary. Once again, our need for this kind of insurance is temporary and not permanent. 

  3. Legacy planning & gifting

    For more affluent individuals, many buy insurance for the purpose of legacy planning (leaving behind financial wealth for the family) or gifting, usually for philanthropic reasons upon their demise. If we are buying insurance for these reasons, we will need it for as long as we live. It is a permanent need. However, we need to mention that there are many other ways of legacy planning and gifting that goes beyond insurance. But it is usually the more affluent that will consider it. Some common ways of gifting is through setting up a trust and putting into the trust properties, investment funds, etc. Of course, insurance has the advantage of setting aside a small capital (in the form of premiums) in exchange for a huge death benefit. One can also place the insurance policy into the trust for the purpose of distribution, gifting upon demise.

  4. Taking care of children with special needs

    For those that may have children with special needs, we may want to ensure that our children can be well taken care of when we predecease them. Insurance is one way of solving this problem. There are 2 approaches to using insurance in this case. 

    1. We can buy an insurance that covers us for as long as we live, so that when we pass on, the insurance proceeds will be able to take care of our children.
    2. We can buy an insurance that covers us till we retire. Meanwhile, we can accumulate towards an amount that will be sufficient to take care of our children, if death occurs after our retirement.

    So for this need, our need for insurance coverage can be a temporary or permanent need.

  5. Providing for alternative medicine and care for children, in the event if they are diagnosed with a dread disease

    One of the worries of parents is that our children may be diagnosed with a dread disease. So if we are buying insurance for the purpose of paying for the cost of alternative medicine and care that is not covered by hospital plans, we will likely need a dread disease insurance for as long as we want it. For this kind of coverage, our need is a permanent need. 

  6. Replacement of a keyman in an organization

    In business, it is often difficult to replace the loss of a key man, such as a CEO or a key employee. The loss of a key man can result in potential business losses. The payout from insurance can replace this loss, until another suitable employee is found. If we are buying insurance for this purpose, we only need to cover the key man till his planned retirement or when he no longer works for the organization. Our need for this kind of insurance is therefore temporary.

  7. Funding a buy-sell agreement contract between business partners

    In business, the death of a business partners can create havoc for the organization, especially so if the surviving owner may have to work with the family members, who have just inherited the shares of the deceased partner. One of the common solutions to solve this, is by way of a buy-sell agreement between partners, whereby both partners agree to sell to each other their shares upon one of their demise. But in order for the surviving partner to have immediate cash to buy the shares, the partners buy an insurance on each of the partners’ life. When there is a demise, the insurance paid out will be given to the deceased partner’s family, in exchange for his shares. If we are buying insurance for this purpose. We will need insurance coverage until the planned exit of the partners from the business. Our need for insurance in this case can be temporary or permanent, depending on when the partners planned for their exit. Although in our experience working with business clients, the need is usually temporary.


Types of Insurance Needs


Type of Need

How Long Do You Need

Remarks

Replacement of income due to death and TPD of income earner

Temporary - We need it only for a period of time

Higher priority planning need by most people

Replacement of income due to diagnosis of dread disease of income earner

Temporary - We need it only for a period of time

Higher priority planning need by most people

Paying for alternative medicine and care for one who suffers from dread disease

Permanent - We need it for as long as you live

Only if we want this as an option and have a conviction in alternative medicine

Paying off liabilities such as mortgage

Temporary - We need it only for a period of time

Higher priority planning need by most people

Funding children’s tertiary education even after demise

Temporary - We need it only for a period of time

Higher priority planning need by most people

Legacy planning and gifting

Permanent - We need it for as long as you live

Usually done by the more affluent and not a first priority planning need by most of us

Taking care of children with special needs

Can be temporary or permanent

Most of us do not have children with special needs

Providing for alternative medicine and care for children, in the event if they are diagnose with a dread disease

Permanent - We need it for as long as you live

Only want this as an option and has conviction in alternative medicine

Replacement of a keyman in the organization

Temporary - We need it only for a period of time

Most of us are not keyman in an organization

Funding a buy-sell agreement contract between business partners

Can be temporary or permanent

Most of us are not in business and do not need this kind of planning

Table 2.1: Types of insurance needs and whether temporary or permanent?

What if I know that I only need insurance coverage temporarily but I don’t mind paying more for coverage for my entire life?

Today if we have unlimited resources, and insurance needs are our only concern, we can buy as much insurance for as long a cover as we want, even if we don’t need it. Unfortunately because we have limited income, but unlimited planning needs, we really need to prioritise our needs. For every extra dollar we pay to buy insurance that we don’t need, it simply means we will have lesser money to save and invest towards our life goals, such as retirement and accumulating towards children’s education. 

Remember that when we plan for ourselves financially, we are really planning to live and not to die! We buy insurance as a “contingency plan”. We don’t really want to use it. We have insurance, just in case if the unforeseen happens, and we are no longer able to earn an income, an insurance payout allows us and our family to carry on with life. 

So if we buy so much insurance, and especially coverage that we don’t need, leaving insufficient financial resources to save for our life goals, the only way for our family to achieve their life goals is to delay the achievement of these goals (such as retirement) or for us to die so that the insurance payout will fund our lives! What a joke that will be, isn’t it?

So, buy insurance that takes care of your higher priority needs first, then save towards our life goals, such as retirement and children’s education. And if we still have budget, we then buy the extra insurance that we may not need but want.



Conclusion


So how long do we need insurance cover? Based on the above discussion, we will realise that in almost all situations, especially the higher priority planning needs, we don’t need it forever. We only need it for a period of our life, when we are still earning an income, or have dependants that need the income. The only main exception, is, if we are buying insurance for the purpose of paying for alternative medicine or care. And this is provided that we want this option and have a conviction for the use of alternative medicine. 

In other circumstances where we need insurance cover for as long as we live, such as 

  1. Legacy planning and gifting
  2. Taking care of children with special needs
  3. Funding a buy-sell agreement between business owners (which in many instances, could also be a temporary need)

These are either not higher priority planning needs or they are unique circumstances for the minority.
Advisers may argue that clients and not advisers, should determine what their higher priority planning needs are. We submit that as professional advisers, there are times when we must exercise our responsibilities and obligations to our clients, in advising them what is right for them. If we are always giving in to clients every want, we are not advisers, but we become salespeople. 



Chapter 3 - How Much Insurance Do We Need?


We do not think it is right to just use the rule of thumb way (such as 10% of your income going into insurance or insure yourself up to 10 times of your annual income) when it comes to financial planning and in this case, insurance planning. We are convinced that a better way is to understand the needs of each individual. Some of the factors that differ from person to person, that will affect how much insurance a person needs are:

  1. How much of our monthly income do we need to replace on our unfortunate demise?
  2. How many years do we need to replace this income for?
  3. Do we need to pay off our liabilities (such as mortgage) upon our demise?
  4. Do we need to fund our children’s tertiary education, even after our demise?
  5. What is our current insurance situation and how much assets do we have now?

And of course, there could be additional factors, depending on our situation.

Using a case study of 2 different individual profiles of Tony and Peter, we did a needs analysis for them to determine their needs if death or total and permanent disability were to occur.


Scenario: Male, Age 45 (DOB 010171), Non-smoker, family with 1 child


Profile

Tony

Peter

Remarks

Monthly Income

$3,500

$10,000

 

Monthly Income Provided for Dependents

$2,625

$7,500

Assumption: 75% of income used to provide for dependents needs

Dependency Period (years)

15

15

Assumption: inflation-adjusted returns at 0% to keep pace with inflation

Income Replacement

$472,500

$1,350,000

 

Children Tertiary Education

$88,400

$177,000

Guided figures: 4 years non-medicine study & 5-year medicine study respectively in local university

Home Loan & Liabilities

$166,875

$462,500

 

Total Death Needs:

$727,775

$1,989,500

 

Existing Death Cover

$200,000

$600,000

 

Current Assets for Consumption

$30,000

$400,000

Assumption: Cash in bank and investments

Shortfall / (Surplus) in coverage:

$497,775

$989,500

 

Table 3.1: Needs analysis for death, TPD coverage

Using the same case study, we did a needs analysis for them to determine their need of replacing their income if they were to be diagnosed with critical illness or dread disease.


 

Tony

Peter

Monthly Income

$3,500

$10,000

No. of years of income that needs to be replaced

3

3

Total needs

$126,000

$360,000

Existing insurance 

$0

$0

Shortfall

$126,000

$360,000

Table 3.2: Need analysis for critical illness coverage


Based on the above analysis, for the purpose of replacing income, cancelling liabilities and funding children’s education upon demise or total and permanent disability:

  1. Tony will need an additional of about $500,000 coverage 
  2. Peter will need an additional of about $1 million coverage

Based on the above analysis, for the purpose of replacing income upon diagnosis of critical illness or dread disease:

  1. Tony will need an additional of about $130,000 coverage 
  2. Peter will need an additional of about $360,000 coverage

Tony and Peter has also indicated that they want the option of paying for alternative medicine, which might not be covered under hospitalisation and surgical insurance. The amount each of them want is $50,000

 

Tony

Peter

Death/TPD Coverage Needs 

$500,000

$1,000,000

Critical Illness Coverage (Replacement of income)

$130,000

$360,000

Alternative Medicine Payment

$50,000

$50,000

Table 3.3: Summary of coverage needs

To calculate your own life insurance needs, you can go to: Life Insurance Calculator

To calculate your own critical illness needs, you can go
to: Critical Illness Calculator

To read Chapter 4 of The Case of Term Insurance vs Whole Life: Click here



Download The Case of Term vs Whole Life Insurance: A Comprehensive Consumer Guide entire e-book free for a limited time

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