Thousands of AIA policyholders are now embroiled in a dispute with the insurance giant. LEONG CHAN TEIK examines the options before them, how non-AIA policyholders are also affected and the multi-million-dollar legal fights over the same issue in the US and Canada

THERE are two main issues at the heart of the current controversy surrounding American International Assurance (AIA) life insurance policies with the 'critical-year' feature.

First, policyholders say their insurance advisers promised that the critical year would be the 12th or 13th year and that they would not have to pay premiums after that.

Second, policyholders want to stop paying premiums now that the critical year has been reached even though this guarantee was not stated in most, if not all, of the insurance contracts.

The first issue is being debated between the policyholders - estimated to number in the thousands - and AIA, the largest life insurer in South-east Asia.

The second issue, on the other hand, is far more complicated than meets the eye, and results in consequences that many policyholders are not aware of, experts say.

AIA has said it will 'honour the terms and obligations' of these policies but it has yet to clarify just what that means. Will it, for example, honour promises made during the sales pitch even if those promises were not reflected in the contract?

Until AIA clarifies that point, these issues remain murky. And then there is the possibility of legal action if policyholders are not happy with AIA's final response.

To recap the controversy that has unfolded over the last three weeks: It has its roots in the late 1980s when AIA marketed products that proved too alluring for many to resist.

Why these critical-year policies sold well is easy to understand: 'Yes, the premiums are high, but you don't have to pay them until you die, unlike in traditional whole-life policies', prospective customers were told.

The AIA policies paid cash dividends every year into the policyholder's account.

The size of the dividends was not fixed but depended on investment gains made by the insurer using part of the premiums.

The dividends earned interest. Over time, up to the critical year, the dividends plus interest were supposed to accumulate to a size where they were enough to pay for future premiums after the critical year.

In theory, how long could these future premiums be supported? Sources say: Up to when the policyholder reaches the age of 100.

In arriving at when the critical year would be, AIA insurance advisers did projections based on assumptions of investment gains to be made by the insurer.

These assumptions were based on the prevailing market conditions then, which were buoyant. In turn, the dividends that policyholders received earned interest at a handsome 7 per cent a year in the initial years. But over time, this rate slid. Now it's 3.25 per cent.

Because of that and a fall in investment gains by the insurer, the critical year now has to be pushed back by many years if the premiums are to be self-funding, AIA has said.

Policyholders such as Mr David Hui, 36, country manager of a network systems firm, say that the critical year was stated only in the illustration on paper given by insurance advisers.

Some policyholders agree reluctantly that according to the terms of the contract, they have to continue paying the premiums.

Still, they are waiting to see what AIA will do next in addressing a marketing campaign of the late 1980s that some allege was misleading.

But in the meantime, what options do you have if you are a policyholder? First, you could pay premiums until a new critical year emerges.

To determine when this will be, ask AIA to do projections based on current rates of return.

But what if you can't afford to continue paying the premiums because you have a big policy with premiums running into tens of thousands of dollars a year?

Or you just plain refuse to pay as a matter of principle.

Some policyholders fear that after several reminders from AIA, their policies would be terminated.

That is not the case. Instead, sources say, premiums are then paid from your accumulated dividends and interest. Sounds good - but you should be aware of the disadvantages.

Assume you have the cash to pay. Compare the 0.5 per cent earned by your bank savings account with the 3.25 per cent from the dividend account. Clearly, it's better to pay cash.

What happens if you draw on your dividend account prematurely? The dividends dwindle until nothing is left at some point.

Then, your next annual premium will be paid from your policy's 'cash value' - which is the cash you get if you terminate your policy.

It's effectively a loan, at 8 per cent interest a year. You can ask the insurer to allow you to borrow money this way - expensive though it is - to pay future premiums.

If you don't give any instructions, your policy will be converted into an extended term policy covering a limited number of years, instead of your entire lifespan.

The sum insured will still be the same as before, though.

As is the nature of term policies, your beneficiary will not be able to collect any payout if you die after the term policy lapses.

Long before that point is reached, ask your insurance agent: How long will your original critical-year policy stay in force if you draw on its dividends?

The answer is at best an educated guess because it will depend on the rate of return that he assumes.

The situation is similar to when he first sold you the policy and projected that the critical year would be 12 or 13 years on. One key difference now is that he would be using today's low rates of return.

If you don't want to pay cash or draw on your dividends, you can convert your original policy into a 'paid-up policy'.

You don't pay any more premiums and you are covered till you die but the death payout is lower.

How much lower will depend on many factors such as your present age and the amount of premiums paid.