Life Insurers Lowering Projected Investment Returns: What’s the Risk and Return on Participating Funds now?
We looked at the risk and return on life insurance participating funds in this blogpost a year and a half ago. Back then, we found that the insurers’ participating funds performed just like passive funds, despite the higher fees, and that the historical compounded returns on these funds averaged around 4.5%, meaning that insurers can afford to pay their policyholders more than the usual 3.5% compounded returns. What has changed since then? For a start, the life insurers are lowering their projected investment returns on 1 Jul 2021 (see also here and here). Secondly, we’ve 2 more years of data points to reassess the risks and returns on these participating funds.
A Quick Recap of our Previous Findings
In our earlier post, we found that the insurers’ participating funds performed just like passive funds, with no added value from the investment managers (despite the fees paid). To work this out, we used the formula for compounded returns as a function of the average annual returns (x) and the volatility of these annual returns (y):
If the compound returns predicted using this formula (discussed here) match the actual historical compounded returns, then it is likely that the investment fund returns behave like a passive fund with little value added input from the investment managers. If the historical returns are higher than the predicted returns (as in the case for CPF approved funds), then the investment managers are really working for their money and are adding value with their investment decisions. Sadly, for insurance participating funds, despite the fees and expenses paid (covered in the Total Expense Ratio or TER), this has not been the case.
Also, in our earlier post, we also found that and that the historical compounded returns on these funds averaged around 4.5%, meaning that after profit-sharing using the 90:10 rule, insurers can afford to pay their policyholders compounded returns of 4%! However, the reality is that few life insurers actually return their policyholders that much. In practice, most of the realised returns on whole life and endowment policies have been around 0.5% less than that.
To a certain extent, looking for investment returns in whole life and endowment insurance policies is similar to investing in a run-of-the-mill hedge fund: high fees, a cut of the profits, and low returns!
What’s new in 2021?
Life insurers are expected to illustrate at least two scenarios; an upper investment return scenario and a lower investment return scenario to provide a reasonable potential range of the level of benefits.
The upper illustration rate will be capped at 4.25% p.a. and the lower illustration rate will be capped at 3.00% p.a. respectively. This is a reduction from the previous caps of 4.75% p.a. and 3.25% p.a. set by the Association.– Life Insurance Association Singapore
The President of the Life Insurance Association (LIA) Singapore further elaborated:
Our objective in doing so is to provide consumers a more realistic range of projected investment returns so individuals can make better informed financial decisions.
These rates will not affect the actual returns of existing and future Par policies.– Life Insurance Association Singapore
Bear in mind that the last revisions by life insurers to lower the projected investment returns was back in 2013, when they were set at 4.75% and 3.25% as the upper and lower illustrative returns. As interest rates have been falling over the past 20 years, and as most of the investments in life insurers’ participating funds are held in bonds, it does seem reasonable that these projected investment returns need to be adjusted down.
Illustrative investment returns for life insurers in Singapore
|Year||Lower Projected Return||Upper Projected Return|
|2001 to Jun 2013||3.75%||5.25%|
|Jul 2013 to Jun 2021||3.25%||4.75%|
|Jul 2021 onwards||3.00%||4.25%|
Now, the effect of falling interest rates should also show up in the actual investment returns. Or do they?
Life insurers’ participating fund returns
To look more deeply into this, let’s look the returns on the participating funds of the 5 major life insurers in Singapore. One major omission from this list is of course AVIVA, which, due to the merger with SingLife in 2020, probably has not been able to release their investment returns just yet. But the five life insurers here represent the vast majority of the investment funds held in participating funds in Singapore.
Life Insurers’ Participating Fund Investment Returns 2005 – 2020
Numbers displayed like this do not make a lot of sense until we organise them a little and do some simple computations:
Life Insurers’ Summarised Investment Returns 2005 – 2020
|Insurer||Compound Returns |
2005 – 2020
2005 – 2020
|Compound Returns |
2005 – 2013
|Compound Returns |
2013 – 2020
What can we make of this data? Well, compared to the results in our earlier post, the addition of the two extra years of returns in 2019 and 2020 has improved the average returns for all insurers by 0.5%, while volatility has remained the same. While this should be good news, the better returns did not stop a few life insurers from cutting bonuses on their participating policies instead! So higher returns do not necessarily benefit policyholders, even as the LIA claim that any revisions to projected investment returns “will not affect the actual returns of existing and future Par policies“.
What is even more mind-boggling is that the actual returns on participating funds across all 5 insurers is better post-2013 than the period before that, and yet the LIA had reduced the illustrative or projected investment returns back in 2013! So it would not come as a surprise, when we look back, perhaps in 5 years time in 2026, that the actual investment returns post-2021 after the reduction in the projected returns will turn out to be on the same level as before that! So much for “Our objective in doing so is to provide consumers a more realistic range of projected investment returns so individuals can make better informed financial decisions“.
In summary, it appears that life insurers lowering projected investment returns will not benefit policyholders:
Despite better investment returns in the period 2013 to 2020 compared to the period before that, life insurers have cut bonuses for participating policyholders, and also revised their projected investment returns further downwards
What’s going on with the Life Insurers?
What is probably true is that nothing will change for whole life and endowment policyholders in the near term. As the LIA stated “These rates will not affect the actual returns of existing and future Par policies“. As we have seen, the life insurers are probably going to achieve the same sort of compound returns as they have over the last 15 years, even as the upper end of the illustrative range of returns has been progressively reduced from 5.25% to 4.75% and now to 4.25%.
But even as the insurers have been achieving investment returns at the upper end of the range of returns illustrated, i.e. around 4.75%, bonuses have been cut periodically by some of them. The actual returns policyholders have been around 3.5% on average, even after accounting for the profit sharing with the insurers. What this move to reduce the range of illustrative or projected investment returns might do, over the longer term, is to shift policyholders’ perceptions of what a reasonable return on whole life and endowment policies may be. This in turn will help insurers keep a greater portion of the investment returns for themselves.
Now, this idea of insurers keeping a greater portion of the investment returns may sound a bit strange, as insurers in Singapore are constrained by the 90:10 rule, which states that for every $9 of returns from the participating funds declared as bonuses for policyholders, the insurer can recognise up to $1 in profits for itself. So wouldn’t the insurer prefer to pay more to the policyholders so that it can profit more? And how come this flies against the evidence from the insurers annual financial returns that participating funds actually earn little profit for the insurers (less than what what the non-participating funds, which is for the term life policies, earn)?
Why do Life Insurers earn so little from Participating Funds?
To understand what is happening in the participating funds, we need to understand a bit about insurers’ capital. Insurers in Singapore are governed by a set of rules for risk-based capital, which basically states that they have to hold capital against the risks they run in the insurance business, as well as in the asset portfolios, like the participating funds. So far, so good. What is more interesting is what counts as capital for insurers. Apart from the usual paid up shares issued, insurers can also count the surplus value of the participating funds as capital.
What exactly is this surplus value or surplus fund? It is the excess of assets in the participating fund(s) over the liabilities to the policyholders. The liabilities in this case include projected future payments of reversionary and terminal bonuses, as estimated by the actuaries. Hence, by reducing the reasonable rates of return to the policyholders, the value of the liabilities will be reduced correspondingly, and a greater share of the assets in the participating fund(s) will end up being surplus value in the surplus fund.
So, who does this surplus fund belong to? Strictly speaking, it belongs to nobody. It does not belong to the policyholders (even though it was earned from their premiums paid), as their share is accounted for by the value of the liabilities. Nor does it belong to the insurer, since if they did not declare the bonuses to the policyholders, they cannot recognise this as their profits.
But the key thing is that this surplus value can be recognised as capital for the insurer, and this is on a pre-tax basis! Which means that it is cheaper for the insurer not to declare high bonuses and recognise the profits (which will be taxed at a corporate tax rate of 17% before being reinvested as share capital), but instead, keep the excess value in the participating fund(s)! And in turn, this allows the insurer to expand its business more aggressively without being constrained by the need for more capital.
Life insurers benefit most from the lowering of the projected investment returns, not in the form of profits directly, but in the form of higher capital, which can be used to expand the business more aggressively.
Takeaways from this episode
It will take a few more years for the implications of the life insurers lowering of projected investment returns to work through to the policyholders in a series of cuts in bonuses and so forth. Some of this has already started, with the cuts in accumulation rates being announced by at least one insurer. But for the prospective policyholder, the takeaways are as follows:
- The projected investment returns from whole life and endowment policies have been cut, and while this has no bearing on the insurers’ actual investment returns, over time, lower returns will flow through to the policyholders as their expectations of future reasonable returns are reduced as well.
- As the investment managers of the life insurers do not add any value in terms of being able to out-perform a passive fund with the same asset allocation as the participating fund, it is better to save on all the fees, commissions and charges (and future disappointment with bonuses being cut) by doing the investment yourself, i.e. buy term and invest the rest
There is no better time to buy-term-and-invest-the-rest, as returns from whole life and endowment polices will continue to lag their passive benchmarks even more after this!