Do you currently own, or have you seen a policy that looks like this?
Well especially if you’re an owner, you’ve probably asked, or at least wondered – how do I know that I can keep getting the higher of the spectrum? (4.75%)
After all, that means more money for you.
Participating Fund, or Par Fund for short – is definition-ally ‘a fund run by an insurance company that is obligated to pay out yearly dividends as well as the payouts for insurance claims.’
In a participating policy plan, such as your Whole Life Plans and Endowment Plans, the premiums you contribute are automatically placed here in order to fulfill the requisite above.
As you can imagine, most participating funds rack up billions and billions of dollars.
There have been a couple of articles across the last few years from various financial bloggers who have analyzed Par Fund returns with varying conclusions. Some have expressed their cynicism; others have reported it as statement of fact and some are optimistic.
Because a Par Fund is so prevalent in so many of your plans, and Par Fund plans are clearly popular and widely sold – here’s a couple of things you should know about them so that you can consider it a factor and optimize your choice for a plan in the future.
Disclaimer: The following is a fairly complex analysis and is not to be taken as formal financial advice. Please see myself over a formal appointment, or speak to your Financial Advisor.
1) There’s an Investment Factor
It’s a fund, Obviously there’s an investment factor. Duh, Luke. Why’d you say that?
Well just a bit of elaboration -the Par Fund has some distinct characteristics from standard funds, such as:
a) Conservative Dividend structure
The par fund needs to pay out bonuses on a regular basis, which requires income payouts such as bond coupons and dividends. This makes the structure fairly conservative with distinct caps (typically 65% bonds and 35% equities).
Additionally, because bonuses that are declared every year are guaranteed – the Par Fund needs to ensure that this structure is sustainable in the face of downturns, meaning that the growth needs to be a lot less volatile.
b) Asset Allocation needs to be highly liquid in nature
Because the par fund needs to pay out insurance claims, dividends and various things at random points of time, the allocation of the fund needs to be very easily redeemable and claimable.
This typically means some of your blue chip stocks, etfs and actively traded bonds: not because other funds would have yield issues, but the larger Assets Under Management (AUM) would make it easier to do the payouts efficiently.
Smoothening is the act of withholding (and reinvesting) excess profits in good investment years so that the same bonus can be paid out during bad ones.
In English, your 4.75% bonus could still be paid out to you even if your 5 year recorded return of the company is lower than that.
The inverse is also true – you could miss a bonus even though a par fund appears to be doing well on paper in the short term.
So do take note.
Smoothening is determined by actuaries – not the insurance company itself.
There have been several limited ways to address a potential conflict of interest, but ultimately most of the interest is shared – paying shareholders or the company higher than necessary in the short term can have drastic long term consequences, such as financial damage leading to a buyout.
3) There are non-investment factors
In 2017, 3 or more major insurance companies yielded double digits for their participating fund, net of fees.
Pretty impressive for a fund that’s limited to 35% equities.
But the investment and asset allocation component is not the only contributor: a par fund can do extraordinarily well depending on the following common three factors:
a) Mortality/Morbidity Claims – The lower the claims, the more the par fund performs.
b) Surrender Claims – The higher the surrender claims, the more the par fund performs in the long term. Note that in the short term this affects the par fund results negatively.
In fact, some companies may even opt to increase your projected payout, rather than decrease it.
c) Expenses – The lower the expenses, the more the par fund performs.
No amount of smoothening can solve your problems if the par fund regularly reports below expectations for the above three, and especially (c), which brings us to...
4) Expense Ratios
The expense ratios of a par fund are declared and pretty easy to read.
As a general rule, higher expense ratios are not very good. There are a couple of additional considerations one should really look at though, before assuming that you should duck a company with a high expense ratio:
a) Movement of expense ratio and reason for it
What I'm always more interested in is whether a par fund performance expense ratio goes up or down, and for what reason. A low par fund expense ratio for that year may be due to an anomaly, and vice versa.
You, and Financial professionals in particular, should be able to see why an expense ratio goes up or down and for what reason.
If you have an expense ratio that is moving up every year, you should be a bit wary. ?? cx
b) Investment Components
Not all par funds have the same investment components. Typically, more bonds will have cheaper expense ratios than equities, but it can lead to underperformance as well.
c) Acquisition Expenses
Smaller Par Funds tend to have more issues with this, as well as if sales are particularly high for that year - this is because acquisition expenses are front loaded.
In other words: if a company does particularly well that year in their sales, it can lead to a high expense ratio that year.
You might interpret that as a short term conflict of interest, but the long term repercussions are positive (since you have a greater scale and larger pool).
Do take note of the following:
1) Your declared par fund returns are net of fees. This means that the results are reported after deductions such as management fees. For those of you who aren't familiar with active funds, this is actually the case for your funds as well.
2) Look at expected yield of maturity, not just the bonuses aspect.
Recent policies since 2018 come with the below worked out for you. Older policyholders are not so fortunate - you can ask a Financial Consultant like myself to help you calculate net return.
3) Look at the long-term return rates, not the short-term ones:
This is because smoothening is a monkey wrench: something that appears to do badly in the short term could have been paying out bonuses efficiently the entire time.
In a study compiling the par fund results from 2006 to 2016, Tokio Marine was not in a high number of quartiles - yet both AIA and Prudential don't have as good a track record of paying out bonuses as the former. One good way to figure that out is to backtrack even further.
Par Funds are not particularly complex instruments – but it is a factor when it comes to choosing your company plan.
The following types of plans and structures are appropriate for this:
1) Whole Life Plans (for yourself, children or otherwise)
2) Savings/Endowment Plans (for yourself, children’s education or otherwise) (insert link here)
3) Conservative Retirement Plans/Annuities (for yourself, children or otherwise)
A 3 year old can determine the value of a plan by cost alone, and that same 3 year old can tell you the value of a plan if you look at the projections only.
Ultimately, you have to consider a company's par fund as a factor for your consideration.
That's where a professional like myself comes in.
A Financial Consultant (such as the writer of this article) should be able to consider the par funds of the companies they work with as a factor for your decision in choosing a plan for yourself. After all, an insurance policy is a lifelong commitment (or at least a good decade or two).
If you’re looking for solid Financial Advice which accounts for this multivariate factor and more, you can always consult me.
If you are more interested in an aggressive approach, you can always message me for investment advice as well or get an idea of my style if you're not convinced yet.
As one of the Top Financial Bloggers in Singapore (Feedspot, Withcontent.co), I would be happy to answer any emails and questions you may have, as I have been doing for my readers over the past few years - especially about Insurance and Investing, as it is my forte of personal and professional knowledge.
If you have any such questions about the articles and how it may apply to your finances, you can feel free to leave a comment, or drop a message through any preferred medium (if you prefer privacy).
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Money Maverick is a Licensed Financial Consultant with MAS, who specializes in Investments and Critical Illness Insurance.
The views on his blog are strictly of his own opinion and have no affiliation to any of the companies he works with.
Here are some of my resources on:
3) Retirement and Leverage: Leveraging a Private Annuity, Pros and Cons (ft. Jamus Lim)
4) Spending and Saving: The Biggest Spending Mistakes You DIDNT Even Know you were Making (and how to avoid them)
5) Job Assessment: A Case Study on How a $6k/mth GIrl makes MUCH more money than a $10k/mth Guy
6) Financial Optimisation: How I Avoid the Largest 'Fees' of All
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Par Fund Reports (2018, depicting 2017 results)
-Aviva (2019 report of 2018, thanks Hariz)