Compare Term Life vs Whole Life - why Protection Gap keeps increasing despite more insurance cover (Updated May 2020)

28 May 2020
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People buy insurance for protection. However in Hong Kong the most popular insurance products usually do not provide much protection element. Term life insurance is a pure protection product against mortality risk without any savings element, but many insurance agents would tell you that it is not worth buying because you cannot get any money back after the end of the insurance term. Instead they would persuade you to buy whole life insurance with the “benefits” of lifetime coverage and projected return.

Whole Life Insurance – limited protection
Although whole life insurance offers lifetime protection, the death benefit payout is usually limited as the savings component dominates. The insurance industry often talks about “protection gap” and how life insurance is necessary to protect your family. But how much life insurance cover is enough? The general consensus is around five times your annual income as basic coverage amount. For example, if your annual income is $400K, your life insurance coverage should be at least $2 million. 10Life has compared the prices between term life and whole life products on a sum assured of $2 million, and found huge differences as shown in the table below:
(Based on age 35 non-smoker, 10-year renewal for Term Life products and 10-year premium payment for Whole Life products with protection basis)

For Whole Life products, the average annual premium for a male aged 35 is around $67K, which is about 17% of the annual income (assumed to be $400K). It may not sound too much, and the insurance company probably believes you can afford it. However, if you add up your other expenses such as mortgage payment, taxes, living costs, kids school fees, etc., even if you can afford the premium payment today, you may not be able to afford it for the entire payment period. As a result, it is common to see an average Hong Konger who either has a whole life insurance plan that does not provide enough coverage, or has a whole life insurance plan with enough coverage but with an annual premium commitment that is unaffordable leading to early lapse. In either scenario, the protection gap is sadly unfulfilled.

You may be told that the coverage of whole life insurance is lifetime compared to the limited coverage time on term life insurance, which justifies the higher premium. Using the example above, let’s assume after paying total premium of $670K over 10 years, the sum assured of $2 million gets paid out. The payout is only about 3 times the total premium paid. Although the coverage period is lifetime, the leverage ratio is not high at all. This is because a large amount of the premium is used towards the savings element to provide some return to the policyholder, but the life coverage element becomes smaller.

Why agents don’t sell you High-Coverage-Low-Premium Term Life products
If life protection is what you need, the average annual premium for the same scenario above is only around $2,421 for term life insurance. With the same amount of sum assured, the leverage ratio is 82.6 times the total premium paid over 10 years. With enough life protection, you can still use the spare funds on other investment or savings vehicles to generate returns.

So why do Hong Kong consumers rarely buy term life insurance? Of course consumers would not shy away from bargains, but since these products usually have relatively low premium, they offer relatively low profits for the insurance company. Hence traditional insurance companies tend to steer their sales towards high premium products. Also as traditional agents rely on sales commission which is tied to the premium size, they would not waste time selling you low premium products with tiny commission.

For consumers who value protection, it is important to understand if your life insurance can provide enough coverage for your family. If you are afraid of agents hard selling you expensive whole life products, you can consider buying term life products online.

Term Life Online Purchase - Simple Process
For Hong Kong consumers who are used to getting served by insurance agents, is online insurance purchase a “mission impossible”? Our 10Life editor has tried the online application process of digital insurance company Blue using a mobile phone. The process requires the applicant to take a selfie and answer three health related questions, and you find out instantly whether the application is successful or not. It is not difficult even without any human guidance. Policyholders often expect the insurance claim process to be troublesome, but for simple term life insurance the concerned factor is just whether the insured is dead or not which is relatively less disputable (except for suicide within the first policy year). Nonetheless, to ensure entitled coverage can be provided, policyholders should remember to notify their beneficiaries about their insurance policies and make premium payments and renewals on time.

If a policyholder needs to renew the term life policy, the premium would usually increase by age. Some people may worry that the insurance company would increase the premium drastically based on cost inflation, as in the case for medical insurance. In fact as the pricing of term life insurance is mainly tied to mortality claims. As Hong Kong has one of the highest life expectancies in the world, the term life price table adjustments tend to be very small. If Hong Kong people continue to live longer, term life insurance might even get cheaper.

Term life insurance can be a good choice if you want to reduce the protection gap at a low cost. Related product ratings and comparisons can be found on the <10Life Product Decoder>.

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