Sunday, 20 September 2015

Why you should not buy an endowment plan.

To my fellow fresh graduates, congratulations on getting that degree scroll. 

By now, some of you would have secured your job and started bringing the dough home. As we accustom ourselves to the post-college life, many of us are entrusted with a newfound responsibility - managing our finances. How you control your spending and manage your savings will determine whether you can meet your financial goals in life. It is high time for us to maximize our dollars. 

Fortunately (or unfortunately), financial advice are aplenty both online and on the streets. We young tender looking fresh graduates in our office wear are probably one of the prime targets of the preying insurance agents. Buzzwords like 'returns', 'savings', 'beating inflation', and 'miserable banks' interest rate' resonate with your interest. Endowment plans, which are often marketed as a low-risk tool to help you meet financial goals while providing some insurance protections, may hit the sweet spot of many. The guaranteed cash value at maturity also entices the risk averse. 

Barring all the commissions and other fees and charges, endowment is inherently not a bad concept. This got me pondering whether I can build my own endowment using financial products that are highly accessible, while cutting out the unnecessary costs.

Structure of an Endowment

To do so, we need to understand the underlying structure of an endowment plan. An endowment can essentially be broken up into 3 parts, the guaranteed cash value, the non-guaranteed cash value, and insurance protection (usually death and total and permanent disability). In a very simplified sense, we can think of the premiums you paid as being channeled to each of the respective parts in an endowment. The premiums (after deducting all the commissions and fees) are allocated such that a significant portion of it will be used to buy low-risk-low-yield bonds to generate the guaranteed cash value. A small portion of the premiums will be used to pay for the cost of insurance. And finally, the remaining premiums will be invested in higher risk equities. 

The DIY-Endowment

In order to replicate an endowment, I will be combining 3 financial products that are highly accessible to the general public. They are: (1) the Singapore Saving Bonds (SSB); (2) the STI-ETF from POSB Invest-Saver; and (3) a direct term from NTUC income that covers death and TPD. Using this 3 products, I will try to replicate and compare it against the RevoSave (3-Pay-10). The RevoSave is a 10-year endowment plan with a $30k guaranteed cash value at maturity. Three $10k premiums are paid over the first 3 years of the policy.

To ensure the quality of comparison, I have included all the transaction fees for SSB and POSB Invest-Saver. STI-ETF are brought using the dollar cost averaging approach over 3 years at a monthly interval. The projected annualized return of STI-ETF is 9.2% (this takes guidance from the annualized return of STI between 2002 to 2013). The returns of SSB follows the interest schedule as shown on the SSB official page. The cost of insurance is $55 p.a. with a $50k coverage on death and TPD. 

Below is the benefit illustration of RevoSave for a 23 yo female non-smoker.

At 4.75% projected return, the RevoSave would generate a  projected return of $9689 at maturity with an average coverage of $39,158.40 over the 10-year period.

On the other hand, the DIY endowment yield superior performance compared to the RevoSave. The death and TPD is fixed at $50k throughout the 10 years. The non-guaranteed return is $11029.14, while the guaranteed return is $30000.03.

For those who are interested, the code for calculating the figures is pasted here.

Is the assumption of 9.2% annual return from STI-ETF a fair comparison against the projected return of 4.75% in the endowment? 
We must note that the 9.2% is the return from equities. On the other hand, the 4.75% from RevoSave is the return from an investment mix of both equities and other low yielding instruments. As of 31 Dec 2014, the participating fund of RevoSave is make up of 23% equities, 67% fixed income, and 10% of cash/loans/properties. Assuming the low yielding instruments yield an annualized returns of 3% to 3.5%, this means that RevoSave assumes their equities can generate a return of 8.9% to 10.6%. The higher equities exposure (18% in my diy-endowment vs 23% in RevoSave) also means higher risk exposure in RevoSave.

All in all, the diy-endowment is likely to yield better returns, offers higher protection for 9 out of 10 years, able to provide a guaranteed principle, lesser risk exposure, and greater flexibility to customize to your needs.

UPDATE (8 Nov 2015)
Sunday Times published an article titled Make (full) sense of insurance policies on 8 Nov 2015 that highlights important things to look out for before committing to  an endowment policy. The article provides a useful table which compares the investment returns on insurer's most representative participating funds for the past 7 years. Let's take a look at how they compare against my DIY endowment. (Note: I am assuming a risk-free product with similar return profile as SSB exists for the period of comparison)

A quick glance shows that the performance of all funds are comparable. But it is important to note that the returns of the insurer's participating funds are NOT the effective or net returns that policyholders will get. The returns have yet to consider the hefty distribution cost, management expenses, commissions, and cost of insurance. All these cost can easily shave off more than 1.5% of the returns.

Clearly, my DIY portfolio significantly outperformed many of the endowment plans based on past 7 years result. 


  1. This comment has been removed by a blog administrator.

  2. Thank you for sharing such great information. It has help me in finding out more detail about Endowment Plan!