Dear Mr. Tan

An insurance company is marketing a "wealth policy" to me. I have to pay 30% of the single premium and the bank will provide financing for 70% at an interest rate of SIBOR + 0.9% per month.

As projected returns of the insurance policy is 4.5%, I will be able to make the difference on the spread.

For my cash upfront of 100K, I expect to get a return of 10% per annum on this insurance policy for life. Should I take up this policy with premium financing?

TKL REPLY

I have studied the benefit illustration for the "wealth policy". Here are my findings:

a) The projected return is not 4.5% per annum. 

b) The benefit illustration is "illustrated" based on 2 interest rates of 3.25% and 4.75%, or an average of 4%. Both of these illustrated rates are not guaranteed.

c) You have to allow for the deductions made by the insurance company for their expenses and profits. Over the next 20 years, the net return (after the deduction) is likely to be 2.6% (and not 4%).

d) I do not understand how and where you can get 10% per annum for life from this policy. 

You should never invest with borrowed money and think that the interest rate will always remain low. The interest rate may increase in the future to more than 2.6%. Instead of a positive spread, you will get a negative spread.

If you cannot pay the interest on the loan, you have to surrender the policy and suffer a large financial loss.

The policy has a distribution cost of $30,000. This is the amount that is deducted upfront from the premium that you have paid into the policy, and is taken by the insurance company to pay its expenses and profit (including a hefty commission to the financial adviser).

It will take you a very long time, maybe more than ten years, to earn sufficient return on the policy to cover this upfront cost. 

Lesson - never invest with borrowed money. Never invest in a life insurance policy with hefty upfront charges.