How Will the Lower Cap on Par Policy Illustrated Returns Impact Us?

Just a few days ago, The Life Insurance Association, Singapore (LIA Singapore) announced that the life insurance industry in Singapore will lower the caps of illustrative investment returns used in Policy Illustrations (PI) for Singapore-dollar denominated Participating (Par) policies, effective 1 July 2021. The upper illustration rate will be capped at 4.25%, down from the current level of 4.75%.

The move is hardly unexpected. In fact, since the LIA standardized the policy illustrations across local life insurers in 1994, the upper cap allowed for Par policy illustrations has steadily fallen from a high 7% to the 4.75% now.

Still, the recent adjustment will have a large impact on the local insurance business, as the most common whole life, endowment and annuity plans all fall within the category of Participating insurance policies.

In this article, we talk about what the reduction from 4.75% to 4.25% means and discuss whether the actual Par policy returns will be affected. We end by sharing some thoughts on how we could cope with this change.

1. What does the reduction from 4.75% to 4.25% mean?

One very common misconception about Par policies is that the 4.75% (or the new 4.25%) refers to the annualized return of the policy itself. Even many insurance agents out there make the same mistake.

In fact, what this number really represents is the assumed annualized return of the Participating fund of an insurance company. Before the investment returns are distributed to clients' policies, insurance companies still need to make a few deductions, such as management and tax expenses, claim proceeds paid out, etc. Only then, the remaining returns can be credited to clients. 

As such, the expected returns that the policies really generate will always be lower than the assumed Par fund returns of 4.75% or 4.25%.

We can also make another inference. When the assumed Par fund return drops from 4.75% to 4.25%, assuming that the expenses incurred stays the same, then the expected return of the Par policies will also be lower.

2. Will the actual returns of the new Par polices decrease?

With the recent announcement, Mr Khor Hock Seng, President of LIA, also stated that the revised illustration rates are for illustrative purposes only and will not affect the actual returns of existing and future Par policies.

However, this statement is "politically correct" at best and is mainly intended to prevent consumers from rash purchase or insurance agents making exaggerations. 

In our view, the actual returns of the new policies are bound to decrease for two main reasons.

The first is the sustained low interest rate environment, which has a direct impact on the actual returns of participating funds. This is also reiterated in LIA's press release that the objective of the adjustment this time round "is to provide consumers a more realistic range of projected investment returns so individuals can make better informed financial decisions.”

It is an indisputable fact that interest rates around the world have been consistently falling. Lower interest rates lead to lower yields on investment-grade bonds, which insurers rely heavily to generate stable Par fund returns. Currently, the 30-year Singapore government bond only gives a yield-to-maturity as low as 1.87%.

In the future, it will be harder and harder for insurers to find highly rated fixed income investments with good yields. In order to maintain the stability and solvency of its assets, insurance companies will have no choice but to sacrifice long-term investment returns, which will directly translate into lower returns distributed to customers.

At the same time, insurers still have to try their best to keep up to the illustrated bonuses on older policies with higher projected returns, or else they risk losing existing customers. This, too, will limit their ability to distribute higher returns to new policies.

3. How could we cope with this change?

No 1. For those already considering buying Par policies, be it a whole life, savings or annuity plan, I would recommend you make up your mind before the change comes into effect on 1 July. 

Still, you should do your due dilligence to choose a product that suits your needs and gives reasonably good projected returns. 

No 2. With returns of Par policies going south, it is advisable to shift more focus towards investment. Although riskier than Par policies, investment products have the potential to give considerably higher long-term returns. 

Insurance companies have also been working to come up with Investment-Linked Products that are more flexible and charge lower policy fees.

No 3. For those with very low risk appetite, new Par policies after 1 July, despite lower returns, could still be a viable option. This is because, compared with other capital-guaranteed savings tools available in the market, the returns of Par policies is likely to be still a little higher.