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Why Term Insurance Makes More Sense Than Whole Life Coverage

If you have done any research at all, you’ll find that insurance policies are split mainly into term and whole of life. Term policies, as the name suggests, provide coverage for a fixed term and expires thereafter without a payout if no claim is made. Whole life policies cover a person until he/she makes a claim.

Many people buy whole life policies because they think that their need for insurance is greatest when they are old. Sounds sensible, but let’s examine this in greater detail.

The Theory of Decreasing Responsibility

When we start our careers as young working adults, our need for insurance is the greatest. This is not to be confused with the chance of claiming insurance. The chance is indeed low, which is why our premiums are relatively affordable.

However, our cash savings are low, our mortgage is mostly unpaid, our kids are young, and our aged parents are still around. If anything were to happen to us, the financial impact is tremendous.

Compare this to someone in her sixties. She’s out of the work force after accumulating enough to retire, and her mortgage is paid. Her kids are financially self-reliant and her parents are long gone. If she gets sick, her Medishield Life (and private upgrades) covers her hospitalisation, and if she passed on, it’d be a sad affair but hardly a financial impact to her loved ones.

This is the Theory of Decreasing Responsibility: your need for insurance is the greatest as a young working adult.

Given that whole life plans tend to be a few times more expensive than a term policy, working adults who buy whole life coverage tend to overinsure themselves for an age that is few decades away, only to overlook that they have underinsured themselves when their need for coverage is greatest.

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Buy term, invest the rest

Furthermore, there are practical upsides to buying term compared to buying a whole life plan. If a whole life plan costs $3,000 a year while a term costs $1,000 for the sum assured, you can then invest the $2,000 difference.

Now, this has a few advantages over a whole life policy:

Term + InvestWhole Life
Invest in virtually anything with ability to get better returns over the time horizonNo choice; only insurer’s Participating Fund which is too risk averse for a long time horizon
Freedom to stop investing if cashflow is tightPolicy will lapse or start going into policy loan which generates high interest rate
Tweak coverage-investment ratio to your affordabilityOften leads to underinsurance

More appropriate risk-return investments for the time horizon, with greater flexibility and freedom

When you purchase a whole life policy, your money will be invested in the insurer’s Participating Fund. Typical Par Funds are quite risk averse: a small 20 to 30% in equities and the rest in fixed income and other safer asset classes.

This is arguably too conservative for working adults with a time horizon of decades ahead of them. An investing guideline called “the Rule of 100” states that your portfolio should be X% of equities, where X = 100 – your current age. For most twenty and thirty somethings, that’s around 70% – way higher than 30%. Some even propose raising the number to 120.

The historic returns for the US stock market, looking at the S&P 500, is an average of roughly 10% pa¹ since while Singapore’s Straits Times Index did an annualised 9.2% from 2009 to 2018². This is merely just buying the index which is easily done with little hassle or investing acumen involved.

Investing this way also does not require a regular commitment unlike a whole life policy which would lapse if premiums are not paid. During times where cashflow gets tight, you could easily scale back the investing and service only the premium for the term policy. A whole life plan would require your premium to be paid regardless, or you would have to take out a pricey policy loan on your own cash value of the policy.

Lastly, some younger working adults won’t have the budget for a $3,000 whole life policy anyway. They end up buying a $1,000 policy with a third of their coverage needs, ending up underinsured when they need the coverage the most. A term policy lets them get covered first, and they can defer their investment until they’re more financially stable.

Flexibility is a double-edged sword

Of course, flexibility can sometimes be a curse as much as it is a blessing. Instead of buying term and investing the rest, people buy term and squander the difference, either through spendthrift pursuits, or losing money in their investments.

But the effort required in maintaining a term policy with regular investments is next to nothing as long as you are just a little bit involved in your finances. And given that you are reading this right till the end, are you not?

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  1. Investopedia – What is the average annual return for the S&P 500?
  2. Straits Times – Annualised total returns of 9.2% over 10-year period for STI

8 thoughts on “Why Term Insurance Makes More Sense Than Whole Life Coverage”

  1. how about for a newborn? i have heard of parents buying WL, premiums from 15~20 years. so just nice, at 21 years old. the kid is covered for life + cash value

    1. Limiting premiums to 15 to 20 years is merely condensing your premium obligation and taking it upfront, and so you are indirectly paying more due to the time value of money. Nevertheless I do realise that there are practical upsides to this.

      Regardless, if you compare term + invest versus a whole life plan, what do you think the insurer is doing such that they can cover you whole of life? They basically take the extra amount you have paid, invest, take a cut of it, then use the rest to cover you.

      Think about it: there is no magical recipe why an insurance company can insure you, give you returns, and still earn a big profit out of it. Insuring + investing can be done without putting all your money through the insurer. They can take care of our insurance needs through the term policy, while we find better alternatives for investment.

      Buying for a child actually magnifies the impact of an overly conservative 25% equity portfolio. If you have a time horizon of 30 to 60 over years, your 25% equity portfolio is going to do very badly against a 80-100% equity one over the very long term.

    2. I didn’t say that. I’m saying limited payment isn’t as good a deal as it seems to be. You’re just giving up cash flow and time value of money. If you stretch your premiums over a longer time period, you pay less monthly and have more for investment.

      Also, why even insure a kid until 80? Your need for insurance is the greatest when you are young and working, and decreases as you age. Whole life proponents are so fixated on having $100-$200k of coverage when they’re 70-80 they fail to see that they need $500k to even $1 million when they’re in their twenties to forties.

  2. This is fundamentally flawed, if we are talking about just death insurance it makes sense. But when it comes to critical illness insurance which are usually included in the whole life or term insurance, the long term of cost of term insurance no longer makes sense.

    1. I have taken into consideration critical illness coverage. I will probably write a follow-up post with numbers, but in the interim, let’s simply things:

      If you have a $1, 20 cents go towards insurance and 80 cents go towards investing. With a 80-100% equity portfolio, your 80 cents can grow, perhaps to $2 over a few decades.

      With the same $1, 20 cents go towards insurance, and the insurer helps you invest the 80 cents into a 25%-equity portfolio. Can you tell me what is the magic sauce insurers use to make your 80 cents in a 25%-equity portfolio grow to beat an 80% one in the long term?

  3. Hi i agree that going term make sense but i am stuck deciding on the insured till age. Eg. 65 or 70 or 75? Any thoughts and maybe if you are able to share what you chosen and why?

    1. It depends on your comfort level and how long you foresee you require the coverage for. Since it’s to cover one’s financially productive years, the usual retirement age of 65 tends to be the target.

      Some may want to go beyond there for better peace of mind while some may wish to reduce their cost by reducing the tenure.

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