Technical Savings and Investments Information

LIFE INSURANCE AND ANNUITY

The US Life Office Management Association Inc (LOMA) defines a life insurance policy as follows: “A policy under which the insurance company promises to pay a benefit upon the death of the person who is insured.”

Life Insurance

a) Major Types of Life Insurance

Some of the major types of life insurance are summarized as follows:

1. Term insurance: this provides cover for a specified period or term only, and may also be described as temporary insurance. The policy benefit is only payable if the insured person dies during the specified period, and the policy is valid at the time of death.
2. Endowment insurance: this provides for the payment of the face amount at the end of a specified term or upon earlier death. Should the insured survive the term, the policy is said to mature. 
3. Whole life insurance: this involves a policy that is designed to last the whole of one’s life. The fundamental feature is that the face amount is paid on death, whenever that occurs, and not before. 
4. Universal life insurance: this is basically a life insurance contract with the following special features:

(1) It is subject to a flexible premium;
(2) It has an adjustable benefit;
(3) The expenses and other charges are disclosed to a purchaser;
(4) It accumulates a cash value; and
(5) It separates and discloses to the policyholder (unbundles) the pure cost of protection, the investment earnings, and the company expenses.

(b) Advantages of Life Insurance (as an investment vehicle)

- protection against uncertainty;
- suitable for long-term investment (except term insurance);
- protection against loss of income arising out of premature death;
- low risk; and
- accumulation of funds for specific purposes (except term insurance).

 (c) Disadvantages of Life Insurance (as an investment vehicle)
- current cash flow reduced;
- low yield;
- need to have insurable interest at the inception of life insurance policy;
- illiquid (at least in the short term);
- lack of flexibility;
- no ownership of any underlying assets; and
- acceptance of purchase dependent upon underwriting decision of the insurer

Annuity

An annuity is a series of periodic payments to an annuitant for life or other agreed term or conditions, in return for a single payment (premium) or series of payments.  For example, an annuitant pays HKD1,500,000 now to buy an annuity that will pay the annuitant a monthly fixed payment of HKD10,000 for twenty years.

(a) Features of Annuities

Some features to be noted with annuities are:

1. Immediate annuity: this is usually purchased with a single payment, the benefits or installments begin one annuity period (one month or six months) immediately thereafter. 
2. Deferred annuity: the installment payments begin at some specified time or specified age of the annuitant. 
3. Variations: a number of possible variations exist. One provides for installments to be paid for a fixed number of years only (whether death occurs in the meantime or not – an annuity certain). Another provides for installments to be paid for at least a specified number of years, whether death occurs or not, and for life if longer than that number of years – known as a guaranteed annuity (or life income with period certain).

(b) Advantages of Annuities (as an investment vehicle)
- stable cash flow;
- suitable for retiree;
- suitable for long-term investment;
- protection against lack of income arising out of excessive longevity;
- accumulation of fund for specific future purposes;
- regular and guaranteed income;
- low risk; and
- hedge against adverse financial developments.

 (c) Disadvantages of Annuities (as an investment vehicle)
- decreasing purchasing power with fixed payments if inflation exists;
- retiree may outlive the annuity;
- low return;
- illiquid in the short term;
- no ownership of any underlying assets; and
- lack of flexibility.