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A good explanation on participating fund

Insurance contract from 1870
Image by Szilveszter Farkas via Flickr

We seldom hear people talk about participating fund, the fund with which the bonus for your life insurance policy is based upon. Here Mr Tan Kin Lian explains in lay man terms on why is there a need for a particpating fund and what it means to you and me:

When you buy a life insurance policy, you are taking a big risk. You do not know what will be the inflation and mortality rates in the future. In spite of this, you are required to commit a fixed premium payable for many years into the future.

The insurance company does not know the future rates either. So, they have to take a risk. If they guarantee you a favourable rate and the trend goes against them, the insurance company can declare bankruptcy. You will lose a large part of your savings.

If they declare a conservative rate and there is high inflation, you will lose out. The money that you have saved for many years will be paid back to you in depreciated dollars. The insurance company keeps the excess as their exceptional profit.

To overcome this uncertainty, many insurance companies have to operate on a participating fund. The insurance company guarantee a low rate of return on the participating policies, and promises to pay back a large part of the yearly surplus to the policyholder in the form of a non-guaranteed bonus.

This arrangement is fine, provided that the insurance company can be trusted to treat its policyholders fairly in the distribution of the bonuses. But you have to take another risk – can you trust your insurance company to give you a fair rate of return?

In the past, the insurance companies observe a high standard of conduct in the distribution of the surplus. In recent years, this standard has been eroded. Many insurance companies are now prepared to short change their policyholders in the pursuit of more profit for their shareholders or for their sales growth. For example, they declare a lower rate of return on their old policies and introduce new products that give a better return to boost their sales. This is unfair and at the expense of the old policyholders.

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