The HK$19,500 surplus and two investment-linked policies
Mei, 34, and Jon, 36, both work full-time in Hong Kong. Combined gross income is HK$96,000 a month; take-home pay is HK$81,000. Their fixed and discretionary spending averages HK$54,000 a month, excluding insurance premiums. They hold HK$80,000 in a savings account and no other investments. They have a mortgage of HK$4.2 million at 4.1% with 22 years remaining and a monthly payment of HK$23,400, and two investment-linked policies costing HK$7,500 a month in total. On the larger policy they have paid HK$180,000 in premiums; it currently shows a surrender value of HK$104,000 and a death benefit of HK$1.5 million. They say they want to (1) upgrade to a larger flat in five years, (2) fund a four-year UK degree starting in 15 years, and (3) retire at 60. Mei wants to stop both policies this week and put the money into mortgage prepayment. Jon wants to start a monthly equity fund for the child's education instead.
1. Before any product recommendation is made, what must the adviser quantify? Show the arithmetic and explain how each figure would change the recommendation.
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1. True monthly surplus. HK$81,000 − HK$54,000 spending − HK$7,500 premiums = HK$19,500. Any recommendation that consumes more than this is funded by dis-saving, not income.
2. Emergency reserve adequacy. HK$80,000 ÷ HK$54,000 = 1.5 months. With a HK$23,400 mortgage payment and two incomes, a reasonable target is three to six months of essential outgoings, i.e. roughly HK$160,000–HK$320,000. This alone argues against locking more money into a 15-year equity fund or an illiquid policy.
3. Protection adequacy. The larger policy's death benefit is HK$1.5 million against a HK$4.2 million mortgage plus income replacement for two earners and future education costs. That gap must be measured before any policy is surrendered, because surrendering may remove cover the household actually needs - and Jon and Mei are both young enough that term cover is likely far cheaper per unit of cover.
4. Policy economics. HK$104,000 ÷ HK$180,000 = 58% of premiums paid after several years. That figure is not by itself a reason to surrender (surrender penalties are front-loaded), so the adviser needs the internal rate of return, the surrender-charge schedule and the cost of equivalent term cover.
5. Goal matching by horizon. Five years is too short for equity risk; 15 years is not. The flat goal must be funded from capital-stable assets, the education goal can carry equity exposure, and retirement funding starts after the first two are protected.
2. Mei instructs the adviser to surrender both policies immediately. Set out how the adviser should evaluate that instruction, including the evidence required and the reasoning that must not be used.
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Reasoning that must not drive the decision: sunk cost. The HK$180,000 of premiums is gone either way; the only relevant question is whether the forward-looking value of keeping the policy beats the forward-looking value of the HK$104,000 redeployed.
Evidence required before advising:
- Surrender-value schedule and whether a premium holiday, reduced paid-up option or policy loan exists (a pause often beats a surrender where charges are front-loaded).
- Year-by-year internal rate of return net of all charges, compared with a realistic alternative of the same risk.
- The death benefit and any riders, and a like-for-like quote for term cover of the same sum assured - if replacement term cover is materially cheaper, the protection argument for keeping the policy weakens.
- Whether the policies sit inside any tax-advantaged wrapper or carry a guaranteed element.
Decision logic. If the protection is not needed or is cheaper elsewhere, and the net return is inferior to a low-cost alternative after charges, replacement is defensible and should be presented as a comparison, not as an opinion. If the cover is needed and the client's health has changed, replacement may be harmful and the adviser should say so in writing. If Mei proceeds against documented advice, the file should record the instruction, the alternatives shown and her acknowledgement. Commission on any replacement must be disclosed and the switch justified on the client's numbers.
3. Rank the three goals for funding and show how HK$19,500 a month would be allocated, with the trade-offs stated.
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Order of funding - solvency before aspiration:
- Protection and reserve. Top the emergency fund towards three months of essential outgoings (about HK$160,000) before adding long-horizon commitments. At HK$8,000 a month this takes roughly ten months. Check that death and critical-illness cover at least clears the mortgage and replaces income.
- Five-year flat goal. This is a capital-certainty goal; funding it monthly into equities would risk a 30–40% drawdown arriving in year four. Use deposits or short-dated bonds. Five years also means the mortgage-prepayment-versus-invest question matters: prepaying earns a guaranteed 4.1% pre-tax, which is a high bar for a taxable portfolio.
- Education, 15 years out. Equity exposure is appropriate here; volatility averages out and the horizon supports it. This is where Jon's instinct is right - but for this goal, not the flat.
- Retirement at 60. Do not defer it entirely to the end. Starting at 36 with 24 years to run, small regular contributions have disproportionate value, but the household cannot fund all four goals at HK$19,500.
Illustrative split: HK$8,000 reserve top-up, HK$6,000 to the flat fund, HK$4,000 to education, HK$1,500 to retirement - revised once the reserve target is met, at which point the reserve contribution is redirected. State explicitly what is not funded yet and what would have to change (spending, retirement age, flat budget) for the plan to work.