Demystifying Participating Endowment Policies
Participating Endowment Policies or commonly known as Endowment Policies in Singapore and are one of the most popular insurance products in the country. The Endowment Policies are also amongst the most commonly traded insurance policies. Hence, it sounds like a good idea to understand them better. This article is an attempt to demystify them while still keeping the article far from technical!
Before we get into details, ever wondered why they are called participating policies? These policies participate in the profit of the insurance company. The better the insurance company performs the higher the benefits the policyholders get. This also implies that in case the insurance company suffers losses the policyholders’ returns are also impacted. The performance is dependent on several factors but most important of them is investment income. This is exactly why the maturity benefit for endowment policies are not known in advance and generally different from the project benefits illustrated in Benefit Illustration.
Now that we have a flavour for the participating policies, let’s delve a bit deeper. Put simply, when you buy an endowment policy, you essentially open a bank account with the insurance company. You put money into the account by paying premiums at regular intervals and the fund increases with investment income each year just like the bank account. This bank account in insurance parlance is called Asset Share. However, Asset Share is slightly more complex than its banking peer. The simplistic view of Asset Share below would make visualizing it easier though.
Asset Share is the true reflection of the amount of money an individual has contributed towards the maturity benefit. This increases with premiums and investment incomes and reduces due to several charges including commissions, administration expenses and cost of mortality benefit. While the other two charges are self-explanatory, cost of mortality benefit deserves explanation. Cost of mortality benefit is average death benefit paid to a large set of pool. For example, if there are 1000 policyholders with sum assured of $100,000 each and 2 of them die in a given year. The death benefit paid to two policyholders would be shared amongst remaining 998 policyholders. Hence, approximately $201 ($200,000/998) would be deducted from the asset share of each of the remaining 998 policyholders. However, if more deaths occur, the remaining policyholders share the loss with the insurance company. Policyholders also share the profits from the good years when the insurance company experiences a windfall. The higher investment income results in a steep increase in the Asset Share. This is fair since by definition policyholders are meant to participate in profit and loss of insurance companies.
Clearly, the assets shares are volatile. However, the reversionary bonuses declared by insurance companies are stable. This seems counterintuitive given policyholders get sum assured plus the accrued reversionary bonuses at the maturity but are entitled to get asset share. The answer lies in terminal bonuses. While insurance companies declare smoothened reversionary bonuses during the policy term, they choose the terminal bonus to ensure that the policyholders get their asset share. Hence, while during the policy term the accrued benefit of a policyholder may not be reflective of the Asset Share at the time of maturity the two converge!
About the writer: Mr Sumit Ramani is the Chief Actuary of fidentiaX. He is a qualified Life actuary and a computer science engineer with over a decade of experience in (re)insurance business with focus on modelling of life and health products, peer review and business analysis.