“effect of deduction” and the “reduction in yield” on insurance policies
these are 2 terms we should ask about insurance policy
Anyone can explain what these 2 are?
Effect of Deduction
When an insurance agent sell you a life insurance policy, the agent is required to give you a Benefit Illustration. It shows the projected cash value and protection value (i.e the amount payable on death) at various durations of the policy.
There is a column called the "effect of deduction". It shows the amount that is taken away from you at the various durations. This amount is used to pay the marketing expenses, management expenses and life insurance cover.
For example, if your total savings over a period of 30 years is $150,000 and your gain is $100,000 (say), you should get $250,000. If the "effect of deduction" is $60,000, you will only get $190,000. Int his case, the deduction takes away 60% of the gain.
If you invest through other products, the expenses and fees usually take away about 15% and leaves you with 85% of the actual gains. The deduction under a life insurance policy is much higher and usually leaves you with less than 50% of the actual gain.
If you are being sold a life insurance product, ask the agent to show you the "effect of deduction". If the deduction is less than 20%. the policy gives good value. If it is higher, you should look for other investments.
Reduction in yield
If you invest in a unit trust, look for one with an expense ratio of not more than 1%. If you buy a life insurance policy, look for one where the reduction in yield (similar to the expense ratio) is not more than 1.5%. The additional 0.5% is for the cost of life insurance protection.
Most life insurance policies have a reduction in yield of 3% to 4%. This eats into the return that should be given to the policyholder. A reduction of 3.5%, compared to a benchmark of 1.5%, means that one-third of the maturity value is taken away.
I wish to explain the reduction in yield. You can take the projected maturity or cash value of the policy at the end of (say) 25 years and the annual premium to calculate the actual yield, say X. The insurance company used a gross yield, say Y, to project the cash value. The difference (Y-X) is the reduction in yield. For example, if the insurance company uses 5.25% to projected the cash value and the actual yield is 2%, the reduction in yield is 3.25%.
