A larger number of insurance products these days are hybrid ones offering both protection and a degree of return on your money. Investment-linked insurance products (ILP) are a highly accessible form of these – which makes it even more important that the inexperienced investor know what he’s buying when he signs up for a policy.
Know your ILPs
ILPs are essentially life insurance policies, for which your premiums buy both life insurance protection and investment units in a professional-managed investment fund, such as unit trusts.
ILPs provide insurance protection in the event of death, possibly with additional benefits like total and permanent disability, accidental death, critical illness and hospitalisation coverage.
Premiums are used to purchase units in investment-linked funds. Units are bought at an offer price, and sold at a bid price (which is typically 5 per cent lower). The difference between the offer and bid prices goes to defraying the insurers’ expenses.
The bid and offer prices change daily with the performance of the underlying unit trust. The cash value of your ILP then depends on the number of units you have, and their bid price.
There are two types of ILPs.
A lump sum premium is paid at the beginning to purchase units. All of this sum, after deducting administrative and mortality charges for insurance protection, is then invested in units. Beyond this initial lump-sum, you can also pay additional premiums to top up your investment account under this ILP, with more units. Hence, they are basically investment products with relatively little insurance coverage. Only single premium ILPs can be purchased using your CPF savings under the CPF Investment scheme.
This allows you to choose how much of the premium you pay goes into protection, and how much goes into investment. Once the amount to be invested is decided, the insurer works out for you a premium allocation table, which will determine the proportion of each year’s premium that goes into investments. Typically, this allocation increases over the time the policy is held for. Also, in general, regular premium ILPs are usually purchased for protection, as it provides more flexibility to raise the coverage offered to meet your own protection needs.
Of course, any increase in coverage is subject to the insurer’s underwriting approval, as with any other insurance policy.
There are a good number of ways in which ILPs differ from traditional whole life, endowment and term insurance plans such as the investment mandate. You choose the investment-linked fund that premiums allocated for the purchase of units goes to, whereas under traditional insurance plans, all your premiums go into the insurer’s participating fund. The performance of the insurer’s fund depends on investment performance, but also on claims and expense levels.
Whereas the insurer bears the risks of guaranteed benefits under a traditional insurance plan, you bear all the investment risk under an ILP. No bonuses are payable under ILPs, whereas whole life and endowment plans may pay out bonuses depending on the insurer’s profits.
For the young
Samuel Goh of Wisdom Capital, a local firm promoting financial literacy, says ILPs may suit Gen-Y investors well for the following reasons.
“This is very crucial to Gen Ys as we are living in a volatile world,” says Mr Goh. Unpredictable cash flows make ILPs attractive because investors are able to adjust their coverage, top up their investment premiums, perform fund switches, and purchase “riders” like critical illness and personal accident ones to make their insurance coverage more comprehensive.
Also, because an ILP investor can choose from a range of unit trusts managed by the insurer or third party fund manager, he is better able to select funds to match his risk tolerance and investment objectives, while benefiting from the diversification of the unit trust’s portfolios.
The relatively low cost of ILPs is naturally also good for young investors, who enjoy lower mortality charges than older investors. And like all cash value policies in Singapore, the cash value of an ILP builds up inside the policy free of income tax. The death benefit payable to beneficiaries is also not subject to income tax.
Mr Goh cautions that young investors pay close attention to the allocation of premiums in the first few years of the policy, as most of the premiums go towards distribution costs then, which would make surrendering a policy at that point detrimental to the investor. “The usual disclaimer applies – they have to be in for the long haul,” says Mr Goh.
While ILPs will remain attractive due to the flexibility they offer, as well as the offer of coverage and protection at a relatively lower cost, Mr Goh also acknowledges that ILPs are losing popularity in a growing segment of increasingly investment-savvy young people.
“Investment-savvy people would generally prefer to put their money and invest into other asset classes such as ETFs and REITS as compared to mutual funds (under the ILPs) as these asset classes do provide a certain level of stability with regard to investment returns at a lower level of expenses (fees etc),” he says
As with any investment product, investors must understand the ILP they buy. Apart from making sure you know the basic details such as:
“Which is a better option for me? A monthly or annual premium?”
Insurance agents wanting immediate commissions may recommend the annual premium policy, though Mr Goh thinks in general, a monthly premium policy can allow for some dollar-cost averaging.
“What are the charges involved?”
Do ask about both administrative and commission fees, says Mr Goh. There is no shame in consumers enquiring about the commission the policy seller will receive.
“Are switches between funds free?”
Some insurance companies impose a limited number of switches allowed on an annual basis.
“What is the historical performance of funds within the ILP?”
Just as you would if you were investing directly into a unit trust, find out about the funds you are investing in via the ILP.