Understanding the "Critical Year" feature of life insurance policies

22 May 2003

We refer to the current discussions in the press over the "Critical Year" feature, which was stated or illustrated for certain life insurance policies sold before 1 July 2002.

We would like to bring clarity and explain the use of the Critical Year feature in its proper context.

Life insurance companies issue to prospective buyers a "Benefit Illustration" to give an example by way of numeric figures how the features and benefits of the policy work over a period of time.

One column shows "Premiums Paid" and another column shows "Cash Value". The Critical Year is the year which shows the amount of cash value built up, assuming all due premiums were paid, plus declared bonuses or dividends, which would be sufficient to "fund" all future years' premiums, based on certain actuarial assumptions. However, we stress that the total cash value figures are not guaranteed amounts, nor are bonuses and dividends guaranteed.

The purpose of the Benefit Illustration is to provide an example of how the benefits of a life insurance policy might accumulate over time. It shows that a cash value will be built up. However, the actual amount of the cash value is dependent on future dividend or bonus payments that may be declared by the insurance company once a year, every year.

Annual bonus and dividend declarations are dependent on various factors, including the insurance company's actual investment experience. Investment performance is dependent on investment market conditions.

When actuarial assumptions, which include the investment return, are not realised, dividend payments and bonus rates may be reduced. This affects the actual cash values that are vested. Therefore, the Critical Year or break even point will be reached later. In other words, premiums would need to be paid beyond the illustrated Critical Year. In addition, any reduction in future bonuses or dividends declared after the Critical Year option has been exercised may mean that payment of premiums will need to re-commence in future.

Conversely, if investment returns turn out to be more than the yields illustrated, the Critical Year would be reached earlier than was assumed.

Nevertheless, since 1 July 2002, the life insurance industry has decided to remove the illustration of Critical Year. This was done to remove any possibility of misunderstanding on this issue.

We would like to assure consumers and policyholders that life insurance companies have a duty to all their policyholders. Therefore, insurance companies will deal fairly with their policyholders and will honour the terms and conditions of their policy contracts.

Life Insurance Association, Singapore