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Life insurance and the funding of education

Published:Sunday | March 18, 2012 | 12:00 AM

Oran A. Hall, Contributor

QUESTION: In your column last week, the person seeking advice mentioned sending J$30,000 to Guardian Life from his salary for his son's college fund. I am interested in finding out how that works. I always thought Guardian Life dealt only with insurance. Can you explain, please?

- Derr

PFA: Life insurance companies are mobilisers of long-term savings. They sell a wide range of products which offer protection against a variety of risks, including death and disability.

Although they pay out very substantial sums as claims due to the death of their policyholders, they also settle claims to policyholders who are alive, for disability, for example. They also pay out substantial sums to policyholders who choose to withdraw funds from the savings or investment portion of their policy to finance programmed expenditures like education, or even to deal with emergencies.

Life insurance companies are significant investors of funds and are particularly attractive because of the favourable tax treatment afforded the investment income earned on the funds of their policyholders, similar to the treatment afforded death benefits.

Although term policies do not earn investment income for policyholders, other products do. Policyholders benefit from the pooling of their funds with the funds of other policyholders, the diversified portfolios that their funds become a part of and the investment expertise of the investment managers of the companies. Sounds like a unit trust, does it not?

Depending on the type of policy, the policyholder may have access to a significant portion of the savings or investment value of the policy at any time. Many persons do withdraw such funds from their policy. Some policyholders forget the long-term nature of their insurance policy and literally strip them of their investment value.

In the particular case you mentioned, he could have purchased a policy with a maturity date, 15 years from the issue date, for example, and which would be close to the time when his son is expected to be in college. At maturity, the insurance company would pay out the investment value of the policy, thus making funds available for his son's college education.

It is also possible that he purchased a universal life policy, for instance, or any other kind of policy which allows him to access the savings of investment value of the policy. In this case, the policy would still remain in force even after the withdrawal of the funds.

interest-sensitive products

It is quite possible that the policy or policies he bought were interest-sensitive products or equity-linked products. The returns on the former are tied to the rate of interest on instruments selected by the insurance company.

In the case of the equity-linked policy, the investment return is determined by the performance of the diversified portfolio in which the funds are invested. The returns are more certain on interest-sensitive products but generally lower than on the more risky equity-linked products.

It is quite likely that the gentleman estimated how much the college education of his son is likely to cost and made a decision that the J$30,000 sum is what it would take to meet those expenses then. It is also possible that he is planning to make lump-sum payments on the policy.

These will not increase his coverage but will certainly increase the size of the investment fund. Being a life insurance product, the policy should have death benefit which could go some way in providing funds to educate his son in the event of his premature death, assuming that the son is the beneficiary.

Here is another possible option, though I doubt that the father took that course. He could have decided to provide for this son's college education on a worse-case basis.

In this case, he would have estimated what it would cost to pay for his son's college education and bought sufficient insurance to generate a pool of funds in the event of his death before or during his son's college years that, when invested then, would yield sufficient income to cover the costs of his son's education.

There was a time when local life insurance companies marketed policies for specific needs such as education and housing. It does not seem that they were able to serve the purpose for which they were conceived.

Regular policies are used to meet many needs other than providing funds for beneficiaries upon the death of the policyholder. But there is no guarantee that the required funds will be generated to meet the policyholder's objectives.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of "The Handbook of Personal Financial Planning", offers free counsel and advice on personal financial