To support economies amid COVID-19, central banks worldwide are cutting interest rates and are expected to keep interest rates low. This has had an adverse impact on the Participating Fund of insurers which in turn will affect the guaranteed and non-guaranteed returns of your par policies.
If you have bought an insurance plan for wealth accumulation, retirement and legacy planning with guaranteed and non-guaranteed returns, likely that it is a participating plan where your premiums are pooled into the Participating Fund (or Par Fund in short) of the insurers.
To support economies amid COVID-19, central banks worldwide are cutting interest rates and are expected to keep interest rates low. Coupled with changes in the Risk-Based Capital (RBC) framework, which was first introduced in Singapore in 2004, this has had an adverse impact on the Par Fund of insurers which in turn will affect the guaranteed and non-guaranteed returns of your par policies.
Understanding Participating Fund (“Par Fund”)
Premiums of par policies are pooled into a Par Fund and are invested in a wide range of assets. Bonuses are then determined based on the performance of the Par Fund, which is dependent on investment returns of the asset mix, market outlook, how many claims are made on the Par Fund and the expenses incurred by the Par Fund.
Par policies provide guaranteed and non-guaranteed benefits through returns generated by the Par Fund.
· Guaranteed benefits: This is the amount you will definitely get when the policy matures or when you qualify for the payout.
· Non-guaranteed benefits: Includes bonuses and cash payouts that you may receive but the actual amount may be affected by the Par Fund’s investment performance and insurance experience. There are 2 common types of non-guaranteed bonus:
· Reversionary bonus is a regular bonus, usually declared annually, that becomes a permanent addition to your guaranteed benefits.
· Terminal bonus is a non-guaranteed, one-off bonus payable when the policy matures, when you surrender it or when a claim is paid.
Hence any changes that can affect the returns generated by the Par Fund will have a real impact on the guaranteed and non-guaranteed returns of your par policies.
Impact of Changes to the RBC Framework and COVID-19
Before March 2020 when insurers adopted RBC 1, they only had to back the guaranteed returns of the par policies in the Par Fund with bonds. To achieve that, insurer typically allocates around 70% of the premiums pooled in the Par Fund to bonds (government and investment grade corporate) and 30% to equity/property.
The average expected long-term returns on these are 2.5% p.a. for SG government bonds, 4% p.a. for investment grade corporate bonds and 8% p.a. for equity/property investments to achieve a weighted average return of 4.75% pa which is the upper illustrated investment rate of return which you will see in the product illustration when you buy a par plan.
However, effective from March 2020, insurers are required to adopt RBC 2 which is a more comprehensive regulatory framework to enhance protection for par policyholders. Significantly, there are 2 key changes:
· Given the greater liquidity in the bond markets, the Monetary Authority of Singapore (MAS) expects the guaranteed cash flows from assets invested by the Par Fund to match the guaranteed insurance liabilities, i.e. the guaranteed benefits of the par policies. Insurers are required to hold higher capital requirements if it is not the case.
· Risky assets such as equity and property also attract higher capital requirements from the insurers to reflect the greater volatility of these assets.
To implement these changes, since the start of 2020, insurers are switching short-term bonds to long-term bonds to match their guaranteed liabilities which are for many years later and in so doing reduce their capital requirements.
Then came the whammy of COVID-19 in 2020 which pushed governments all over the world to cut interest rates to support their economies which resulted in lower yields for investment grade bonds. With lower yields, insurers are forced to set aside more of their capital to match their guaranteed insurance liabilities, hence reducing their ability to invest in higher yielding assets. Some insurers may have had to sell off equities in the Par Fund at low prices if they did not have enough capital to support these investments.
All these actions undertaken by the insurers will bring down the returns generated by the Par Fund and will likely result in a challenge to hit the 4.75% p.a. target as highlighted above.
What Does These Changes Mean for You and Me as Consumers?
To ensure the sustainability of the Par Fund by freeing up more capital to invest in riskier assets to achieve the targeted return, insurers have started to shift their product design by lowering the guaranteed benefits for their par plans in light of the lower bond yields. Several insurers had begun to reprice their products to give lower guaranteed returns and others are expected to follow.
Annually, the Life Insurance Association of Singapore (LIA) reviews the investment rate of return used in policy illustrations of par plans to ensure relevance and appropriateness. In light of the mentioned lower returns expected from bonds, which generally forms a significant proportion of the asset mix in the Par Fund, the current 4.75% pa illustrated rate of return in product illustration will also drop to 4.25% pa as a result of the economic fallout from COVID-19. We can also expect bonus revisions for existing policies (may not be all) to be reduced as a result.
But Are Low Product Guarantees Necessarily Worse off Than High Guarantees?
In general, the higher the guarantee benefits in the par plan, the lower will be its total benefits (including non-guaranteed benefits) to you as the policyowner. So, likewise, for a par plan with lower guarantee, there is greater leeway for the insurers to free up capital to invest the Par Fund into more equity/property assets which in turn will generate potential higher total returns for you in the long run. Hence low product guarantees may not necessarily be worse off than high guarantees.
Act Now and Seek Advice
Despite these challenges, par plans remain needed and relevant to consumers like you as it can form the foundation of your financial planning needs especially in the area of protection and retirement-planning.
With these changes that has happened or is likely to happen, you should act now and seek advice from a financial adviser representative who can recommend you and compare par plans across insurers. The financial adviser will be able to help you evaluate the plan based on total investment returns as well as guaranteed returns. In addition, the financial adviser can also help you to evaluate the financial strength of the insurer and its Par Fund to ensure your claims can be made.
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