We all probably know someone in the insurance line, and it’s very likely that you would have been asked to consider purchasing an investment-linked policy (ILP).
We’re told that it’s a way to grow your money while staying protected. But how exactly does it work?
Part insurance coverage, part investment
At the core, ILPs are still insurance policies — meaning they will provide financial protection in the event of death or total permanent disability. What makes ILPs different from other life insurance products are that it’s linked to additional investment components. It’s pretty much a 2-in-1 deal, though not without its own risks (which we’ll address later on), like any other investment.
ILPs typically come in two forms:
- Single premium ILPs, where you only pay a lump sum. These provide lower insurance protection than regular premium ILPs.
- Regular premium ILPs, where you pay premiums on a regular, ongoing basis and can tweak the level of insurance coverage provided.
The investment money (or premiums) you pay are used to purchase what we’ll refer to as units in a fund. A fund is essentially a type of investment where retail investors can pool their money — the fund manager will use this money to purchase assets like shares or even bonds, depending on what type of fund it is.
These units are priced according to the fund’s performance.
How ILPs work
Here’s an example. Let’s say you just bought a single premium ILP that’s front-end loaded. The policy requires a yearly premium amount of $5,000. You’re only paying this once a year — but how is that money utilised? It might look like this:
|Policy Year||Percentage used for buying units||Percentage used for insurance expenses|
|1||15% ($750)||85% ($4,250)|
|2||30% ($1,500)||70% ($3,500)|
|3||50% ($2,500)||50% ($2,500)|
|4 – 9||100% ($5,000)||–|
|10 onwards||102%* ($5,100)||–|
*The additional 2% will be paid by the insurer, though this depends on your policy.
What about the payout?
Depending on the policy, an ILP’s benefits will be taken from the following, whichever is higher:
- The sum assured;
- The value of the units in that fund; or
- A mix of both.
And, for those antsy about having their money kept from them: ILPs allow you to withdraw money from the investment fund portion at any point in time (so your units have to be sold off), whether it’s to fund an important expense like education or to help fund your house.
You can even take something called “premium holidays” where you can skip paying the monthly premium to attend to other financial needs. During these periods, your premium will still be paid — just by the investment portion where your units will, once again, be sold off.
So, what’s not to love about an ILP? It sounds perfect — you can cover yourself in the event of death or disability (so your dependents are protected, should you lose the ability to earn an income!) while still growing your hard-earned money. And you’ll constantly have access to said money at any point of time for liquidity.
Well, it’s not quite as simple as that.
No returns guaranteed
It is an investment after all, hence, there’s a certain level of risk involved, the same way there will be risk involved when you buy stocks on your own, or any investment vehicle, really. And as investors, it’s on us to bear the full risk of what we’re getting ourselves into. Thus, no one, not even your agent, can guarantee you investment returns as ILPs usually do not have any guaranteed cash values.
At best, they can only project these numbers, and when they do well, you can get good returns, but as with investing as a whole, no one can really predict what happens in the markets.
Another major financial drawback concerning ILPs are the additional and hidden fees involved.
ILPs typically charge an initial investment fee, which is separate from the monthly premium that you’re paying up. Depending on the policy, this fee could be 2% of your total investment amount.
For example, if you’re planning to invest $30,000 through an ILP, you would have to cough up an additional $600. This is an extra sum of money that you are paying just so you can invest in a particular fund.
This is similar to investing in unit trusts, where you pay professional fund managers to invest your money for you — and hopefully earn great returns. This hefty fee you pay will never come back to you in any way. It’s something to consider, if you’re already working on a tight budget, but you still want to invest.
ILPs may also contain hidden fees, such as monthly recurring charges. While an agent might tell you that you don’t have to worry about these recurring charges, the fine print tells a different story: that it is within the rights of your insurer to charge you a monthly fee whenever they see fit.
Depending on how well the fund performs, or how poorly, these additional charges might just end up negating your returns and cost you money instead, at least on the investment front.
Who are ILPs best suited for
You might be wondering who ILPs are for if there are hidden costs and no surefire returns on your investments.
Well, if you’re someone who values flexibility in their insurance policy, and would like to be able to customise and tweak the coverage and benefits, ILPs let you do that.
Why would anyone want that flexibility? Because financial situations can change over time. For example:
- A new stage of life: You’re at that point in your life where you have a baby on the way. You want to ensure that your insurance policy gives enough coverage for everyone in your family — so you make the decision to increase the sum assured of your ILP from $500,000 to, say, $1,000,000.
- A change in your investing needs: You decide you want to be more aggressive with your investments — you can reduce the percentage of your premium dedicated to insurance costs to only 30%, and divert 70% towards buying more units instead. (In fact, some ILPs are designed more for wealth accumulation than for protection to cater to those of us who want to go ham on our investing.)
ILPs might also be suitable for people who know zilch about investing, and are either too busy or too intimidated by investing as a whole to even dip their toes in the lake.
In this case, it might be easier to let someone else handle their investments. It’s probably much easier than getting on a brokerage platform and attempting to stock pick all on their own!
In summary, while ILPs have a bad reputation, they might work for your needs. You just need to be aware of how they work and what exactly you’re paying for.
READ ALSO: A glossary of common types of insurances