Private Client Services by Mercer
As Mercer PCS Singapore CEO, Davin Wong, points out – it’s a little wild out there. Rising interest rates, runaway inflation and the threat of stagnation are adding even more volatility to our lives and the markets.
In this issue of Vision, we tackle the effects of rising interest rates on wealth and legacy planning through life protection, Isaac Lim (Mercer PCS Managing Director) explores the difference between Universal Life Insurance and Whole of Life policies, and two case studies illustrate the criticality of reviewing life insurance policies regularly.
Evergreen in a season of change: How rising interest rates are affecting life protection
It’s a little wild out there. Volatility everywhere you look, and after a prolonged period of historic lows, interest rates are rising globally as central banks across the world try and curb the hottest inflation rates in four decades. Mercer PCS Singapore CEO, Davin Wong, explains the effects of raising interest rates and the changing shape of the USD yield curve on life protection products. He demonstrates why – when it comes to life insurance and legacy planning – high net worth (HNW) and ultra-high new worth (UHNW) individuals can keep their eyes on the long-term goals of their core portfolio and weather volatility. He also outlines the beneficial effects of incorporating life insurance into one’s portfolio despite the changes in the interest rate markets.
How do the increases in interest rates affect life insurance solutions for HNW and UHNW clients?
Any investment product with a long tenure is sensitive to interest rate movements. In life protection solutions such as Universal Life Insurance (ULI) and Whole of Life Insurance (WoL) – which have a significant investment component – the time value of money impact is amplified in the composite instruments.
Investment components embedded within the policy design supporting life protection solutions, such as ULI and WoL policies, are generally heavily weighted in bonds. In a rising interest environment, clients will note the yield on existing solutions will rise. This will have the positive impact of reducing the upfront premium payments as the returns derived from the investment components in the policies are “marked” to market.
But beyond yield, the primary objective of protection is in itself important, and life insurance remains a highly effective wealth planning and estate transfer mechanism, unaffected by fluctuating volatility.
The changing shape of the USD yield curve
We have seen in the past 15 years a period of normal upward sloping yield curve. This has allowed HNW individuals to take advantage of accessing the favorable short-term interest rate in funding a premium to incept a protection life policy.
The changes in the global interest rate markets have also seen the shifting shape of the USD yield curve – it has flattened somewhat. This effectively means that it is less economical for HNW clients to access the short-term loan markets to fund a long term instrument such as a life policy. On the other hand, raising a loan helps HNW clients with the liquidity to implement his/her estate and legacy plan.
An alternative to raise liquidity, which may be considered by HNW clients in the current flat yield curve environment, is to fund the life policy through a multi-pay option offered by the insurance company.
Multi-pay as premium financing
Multi-pay premium financing enables the client to spread the cost of purchasing a life insurance policy over a period of time while locking in the current low interest rates.
A multi-pay option is in effect, a premium loan provided by the insurance company at a competitive fixed-loan rate. The loan is repaid by way of multiple equal instalments – which could be over a number of years – and can be repaid without any early repayment penalty.
A multi pay option can be seen as premium financing provided by the insurance company based on a fixed rate. The client implements a ULI or WoL solution in order to put in place a high value of protection.
In essence, premium financing also improves the client’s liquidity. Effectively, the client would utilize less cash/liquid assets in acquiring long-term protection. When a bank premium loan becomes uneconomical to implement, credit can be provided by the insurance company in the form of a multi-pay option.
Sensitivity is a short-term notion in the evergreen subject of life protection
The need to think long-term is an especially pertinent one for Northeast Asia, which has three of the top ten UHNW countries. It is where much of the wealth remains in the control of the generation which created it, who are younger, on average, than the HNW individuals of other places such as the United States.
The transfer of that wealth over the next few decades requires thinking on a generational timescale as well as careful planning, and as such, it is an evergreen matter.
Evergreen matters ought not to be subject to the short-term volatility and the fluctuations of interest rates. Life protection is a safe, long-term asset class, providing stable liquidity and a proven estate-equalization/wealth transfer tool.
The functionalities that high value protection policies bring to the portfolios of HNW individuals are long term. Changes in the capital markets (including interest rate markets), in the manner described above, will not alter the way HNW individuals can continue to use these functionalities in their estate and legacy plans.
We note also that whilst legacy planning is a long-term proposition, once implemented, annual reviews with life protection consultants are particularly crucial. Life changes, at times dramatically, so it’s important that clients are regularly updated on the performance of their solution, and the solution continues to meet their needs and objectives.
The seven key differences between Universal Life Insurance and Whole of Life Insurance*
The decision to incept a life insurance plan to safeguard you and your family as well as maintain peace of mind is a relatively easy one to make. But choosing the right insurance products from the vast array of available options is not as simple. This is especially true as protection products continue to evolve in sophistication as financial instruments.
In this article, Mercer PCS Managing Director, Isaac Lim, clarifies the key differences between Universal Life Insurance (ULI) and Whole of Life Insurance (WoL) in Asia.
A brief look back at ULI and WoL in Asia
Trends in life insurance plan have generally been driven by a combination of product innovation and investment market conditions. In Asia, high net worth (HNW) individuals have had Universal Life Insurance for over 20 years.
Whole of Life solutions came into wider usage around eight to nine years ago for HNW individuals, as it evolved to better complement their growing financial complexity and needs. In recent times, with the availability of premium financing and more competitive premiums, more high net worth individuals are considering Whole of Life solutions.
Some things in common
Both WoL and ULI combine life protection coverage with savings elements. And in most cases, policy holders can borrow against the cash value of the policy.
WoL and ULI are popular insurance plans for HNW clients who want protection for their family, wealth transfer, and estate-equalization solutions.
Premiums for both types of protection solutions are determined based on actuarial projections.
Seven key differences
Whilst there are individual product variations within the two categories (as insurers continue to build new and better product features to make permanent life insurance more attractive) there are also some fundamental differences between ULI and Whole of Life products.
As demonstrated below, Whole of Life policy benefits and contributions are guaranteed and level. ULI provides flexibility in lieu of those guarantees.
With Universal Life policies, you have more flexibility to structure the policy according to your needs – like overfunding in the policy. How much you pay on your policy then directly affects the fluctuation of the policy’s cash value and death benefit. Instead of guaranteed or non-guaranteed dividend/bonus like WoL, ULI policies are credited based on interest rates and have a minimum guaranteed crediting interest rate.
A side by side comparison
Universal Life Insurance
Whole of Life
Investment only in investment-grade bonds
Government and corporate investment-grade bonds.
Investment in investment-grade bonds as well as other asset classes
Only 50-60% of WoL investment is invested in bonds. The remainder is invested in other asset classes such as equities, mutual funds, and real estate investment trusts.
Transparent crediting interest rate and cost that can change over time
The crediting interest rate and cost of insurance are transparent, so policy holders understand their cost of insurance deducted from the account value and the amount of interest credited to the policy.
The dividends and cost of insurance are not transparent.
Possible to increase or decrease death benefit without surrendering your policy
You can adjust the death benefit as required, increasing it (often subject to a medical assessment) if your circumstances change, or lowering it to reduce premiums.
Fixed and guaranteed death benefit
Death benefits are guaranteed. Depending on the insurer, death benefits can be guaranteed up to age 100 or age 120.
Cash value potential, but not guaranteed
If there is enough cash value in the account, you have the flexibility to withdraw cash, and this can affect the death benefit.
Guaranteed cash value during policy holder’s lifetime
The cash value grows as the annual dividends are credited to the policy. The dividends can be withdrawn without affecting the death benefit.
Policy at risk of lapse
If the investments perform under expectations for an extended period of time, and the cost of insurance is at the maximum amount, there is the risk of policy lapse.
No risk of policy lapse
As long as the premiums are paid, WoL policies will not lapse.
Whilst the key differences between WoL and ULI can be demonstrated, Mercer PCS believe the real life application of any product should absolutely depend on the unique circumstances of each individual’s need and planning for his or her family.
When making life protection decisions, circumstances such as age, health, risk profile, family structure, financial goals, lifestyle, and cash flow must be carefully considered, all the while taking into account the continuous emergence of new insurance products and features. The complexity means HNW individuals are advised to seek expert, unbiased advice before making any crucial decisions.
* This article is general in nature and not intended as advice; it might not be appropriate to you.
Case study: Why changing to a Whole of Life policy was the right choice for this client
Client is a 64 year-old female and a highly successful business owner. She has two adult children; the younger son is working in the family business while the elder son works as a professional and is not involved in the family business.
Our client has a net worth of more than USD50M and her overarching wealth management goal is to find a suitable estate-equalization solution which also protects the family’s wealth.
Her elder son is a Green Card holder and therefore subject to worldwide income tax, capital gains tax, and where applicable, gift tax.
The client held an existing Universal Life Insurance (ULI) policy of sum assured USD10M, which was incepted in 2001. In her search for a better solution, the client spoke to a number of insurance brokers and private banks.
After thoroughly understanding our clients’ financial and personal positions, we presented her with three Whole of Life (WoL) options because WoL policies offer guaranteed death benefit without the risk of policy lapse.
Option 1: Place a WoL policy with a reduced sum assured using ULI surrender value of about USD1.4M as premium for the new policy
Option 2: Place a WoL policy with the same sum assured of USD 10M using the surrender value plus premium financing (without cash outlay)
Option 3: Place a WoL policy of sum assured USD16M to achieve net sum assured of USD10M using surrender value, premium financing, and cash outlay of USD497K
Case study: Finding solutions when others fail
53 year-old male client has a net worth of about USD60M. He is married and has four kids studying abroad. He is in good health.
Our client purchased a Universal Life Insurance (ULI) policy in 2013. During the recent annual policy review, we noted that the policy’s crediting rate had dropped, and the cash value will also start dropping. We agreed with the client’s concern about the declining returns, especially in the context of his wealth and legacy planning,
The client wanted to explore alternatives and was open to the possibility of switching his ULI to a Whole of Life (WoL) policy.
With the better medical result and reduced piloting, Mercer PCS petitioned to a few of our insurance providers asking them to waive the loadings for piloting. The client was therefore offered a number of Whole of Life options without a “dangerous hobby” loading. He chose to surrender his ULI policy:
The entire process, from review to changing policies was concluded within two months, and the client is very satisfied with the final offer.