Does it make sense to buy a new life insurance policy and not reinstate the existing policy?
Well, that’s exactly one of the questions we received as part of the recent #AskTheActuary session. While I did answer the question on Twitter, I believe this question deserves a more comprehensive response and this article is aimed at answering the interesting question that Lily asked. Before I go on to share my analysis, I wish to thank Lily for the thought-provoking query.
To be honest, Lily has a fair argument especially when she says, “Why would I want to pay past premiums where I was not covered?”. To understand the argument better, let’s take an example. Let’s assume that, in 2008, Lily bought a term insurance policy when she was 30 years. The policy was meant to cover her till age 65 years for a sum assured of SGD 200,000. Realistically, her annual premium would have been around SGD 225. Fast forward to 2018, she is 40 years now and has paid premiums for 8 years and policy has been in lapse state for 2 years. She is now contemplating whether she should pay 2 years premium along with penalty to reinstate the contract or buy a fresh policy. The two year’s premium would amount to SGD 450 and the penalty is say, SGD 150. The original question then translates to, “Would it make sense to pay SGD 600 for the time I was not covered and reinstate my contract? Instead, wouldn’t it be wise to buy a fresh one?”
Prima facie, it does look like reinstatement would mean wasting 600 bucks. But one also needs to think about the future. Now that Lily is 40 years old, the premium for new policy would be around SGD 350, which is an additional premium of SGD 125/year as opposed to the existing contract. The policy contract is till age 65 years. So as of 2018, there are still 25 years to go given Lily is aged 40. For the sake of argument, let’s assume that Lily wishes to continue the contract for at least 10 more years i.e. till 2028. That being the case, reinstatement would have saved her SGD 650 over a 10-year period of time. Wondering how did I arrive at a saving of SGD 650? Following is the calculation.
Scenario 1: Reinstatement
Total Premiums paid for the period of 10 years starting 2018: SGD 225 X 10 = SGD 2,250
Premiums and Penalty paid for reinstatement (for 2016–18): SGD 600
Total outgo: SGD 2,850
Scenario 2: Fresh Policy
Total Premiums paid for the period of 10 years starting 2018: SGD 350 X 10 = SGD 3,500
Premiums and Penalty paid for reinstatement (for 2016–18): SGD 0
Total outgo: SGD 3,500
Additional outgo in case of Scenario 2 when the fresh policy is bought: SGD 3,500 — SGD 2,850 = SGD 650. The savings would be more if Lily continues the contract longer than 10 years
Clearly, it makes little financial sense to buy a fresh policy especially when one has a long-standing contract and wishes to remain covered for some more time. But the benefits of reinstating don’t end there. Following are the additional key benefits when compared to buying a fresh policy
· Medical Test: Buying a fresh policy could mean that one will have to go through fresh medical tests. While reinstatement, in most cases, would require a declaration of good health.
· Incontestability Clause: Most life insurers have this clause in the contract with the intention to provide protection to policyholders. This, in simple terms, means that insurers cannot deny the claim after the policy has been in force for a few years (usually 2 years). The exception being the cases of fraud. For fresh policy one will have to wait for another 2 years!
While reinstatement is a better option when compared to buying a fresh policy, it is even better to ensure that the policy never gets lapsed. That way one continues to remain covered and can save on penalty for reinstatement. In case you are forgetful like me, ISLEY — your insurance buddy can come handy here. Of course, it is a lot more powerful than notifying when insurance premiums are due. I have talked about the features and the advantages of ISLEY in my previous articles, which you can find here.
Before I sign off, I must thank Lily and the readers who send us queries on life insurance. It is because of your queries and feedback I get inspired to write frequently. The impact of your queries is far-reaching as it also helps our silent followers who learn from your queries. I would strongly recommend you send us your thoughts at hello@fidentiaX.com or ask your questions on Twitter. I would be live again at 8 PM Singapore time on 26-November-2018 i.e. this Monday!
Disclaimer: The article has been written with an aim to broadly explain an otherwise complicated and technical topic for readers with little or no insurance background. Hence, it doesn’t have finer details but is still broadly correct. The readers are recommended to take advise from their respective financial advisers before taking any financial decision.
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.