By and large, every life insurance company in Singapore will have their own participating fund. If you are holding onto a participating policy, then you will share the profit generated from the fund’s return. What’s more, the fund protects you against the downside of investing your money directly into the market.

Example of Participating Policy: Participating Whole Life Insurance Policy, Endowment Savings Policy

With this purpose in mind, we will understand more about a participating fund and how it affects you.

Table of Contents:

1. The Basics
2. Returns
3. Risk
4. Choosing a Participating Fund

Part 1: The Basics

Part 1.1: How does it work?

To begin with, the insurance company will take your premium and pool it into its participating fund. This is together with the premium from the other policyholders. Altogether, the insurance company will use this pool of money to invest into a wide range of assets. All things considered, this fund is responsible to

• make benefit payments, e.g. coupon payout, maturity payout;
• deduct expenses; and
• generate returns in the long run.

Part 1.2: Participating Fund’s Objective

Above all, the participating fund’s objective is to provide stable returns in the medium to long-term. In effect, we will receive part of these returns in the form of guaranteed benefits and non-guaranteed bonuses.

Part 1.3: What does it invest in?

Given that it has a long investment horizon, a participating fund can invest into a wider range of assets. At the same time, it does not need to generate guaranteed returns only. Therefore, it is able to take on some risk in order to reap potential returns.

Example of invested assets: Bonds (forms the majority of the fund), Listed Equity, Private Equity, Real Estate

Part 2: Returns

In addition to the guaranteed benefits, a participating fund may distribute two types of bonuses to you.

Part 2.1: Reversionary Bonus

Firstly, the reversionary bonus is a discretionary bonus. In other words, the insurance company may or may not distribute this bonus to you. In reality, this depends on the yearly experience of the participating fund.

Part 2.2 Terminal Bonus

As the term “terminal” suggests, you will receive the terminal bonus when you terminate the participating policy. In the same way, it is a non-guaranteed discretionary bonus as well.

Part 2.3: Smoothing of Bonus

As mentioned in Part 1.2, the participating fund’s objective is to provide stable returns to you. Therefore, most insurance companies will adopt a technique known as ‘smoothing‘.

In brief, the insurance company will keep some of the profit made during the good years. From time to time, it will use this surplus to make up for the shortfall in the poor performing years.

Part 2.4: How to calculate the Return

In sum, we can calculate the participating fund’s return in three steps:

1. Firstly, we will determine the value of assets in the participating fund.
2. Next, we will subtract the value of the guaranteed policy benefits, e.g. previously declared bonuses.
3. Finally, the net amount is available to declare as future bonuses and dividends.

Overall, there exists an incentive for the insurance company to provide a higher return to you. This is because of the regulatory requirements. In detail, there is a 9:1 ratio on policyholders to shareholders’ distribution. In other words, for every $9 given to the policyholder, the shareholder will receive $1.

Part 3: Risk

Part 3.1: Participating fund’s risk

After all, every investment bears some form of investment risks. Consequently, this may affect your returns in time to come. For example,

• Fluctuation in investment;
• Mortality and morbidity experience;
• Lapse and surrender experience;
• Business risks;
• Participating fund’s expense experience

All in all, we will spread this risk among all the participating policies within the same class of products.

Part 3.2: Expenses

As a matter of fact, the insurance company will incur some expenses in order to maintain the participating fund. For instance,

• Death benefit paid to a participating policyholder;
• Investment and management fee;
• Marketing and distribution cost.

In like manner, the insurance company will spread this cost across its participating policyholders.

Part 4: Choosing a Participating Fund

For one thing, the insurance company will declare its participating fund’s performance every year. Thereafter, you will receive an annual fund update.

Summing up, the financial condition and the actual value of the assets will determine the stability of the participating fund. Furthermore, we need to ensure that the fund incurs a reasonable level of expenses. This is together with the amount of payout to meet its obligations.

Additionally, we should also take note on the rate of declared bonuses, alongside with its compounding rate over time. Finally, proven track records ensure that the insurance company is capable to implement smoothing of bonuses effectively.

Checklist:

1. Do you have a participating policy?
2. How well do you understand its participating fund?
3. How do you integrate a participating policy into your financial portfolio?

First Published: 21 August 2019
Last Updated: 27 May 2020