 Photo: FreeImages
This article is republished with permission from Dollars & Sense. |
What are Investment-Linked Policies?
ILPs are policies offered by insurance companies that provide policyholders with both insurance and investment components. Overly enthusiastic agents will call it the “best-of-both worlds”. A more accurate phrase to describe it, in our opinion, would be “worst-of-both-worlds”.
For a regular premium ILPs (policyholders pay a monthly fee), premiums received would be used (after sales charges) to acquire units in a Mutual Fund (or more commonly known in Singapore as Unit Trust) of the policyholder’s choice. Some of these units are then sold off to purchase the insurance component that the policyholder requests for.
| ♦ Flexibility of Investment-Linked Policies |
|
We will start with what is “good” about ILPs before going into what is wrong with them, since the latter has a much longer list than the former. One thing your agent was right about is the flexibility offered by ILPs. |
So What is Wrong with an Investment-Linked Product?
Almost everything else. Let us explain.
Sales Charges
In our opinion, the sales charges that an individual will incur when buying an ILP is simply too expensive. Here is a breakdown.
- Agent Commission
Buying an ILP is one of the few sure ways of helping an agent friend. An agent has A LOT of incentive to be selling you an ILP. Commission payable to the agent is usually worth at least one-year premium.
So if you were to buy an ILP for about $500 per month, your agent will be enjoying a nice commission of about $6,000 from selling you the policy. - Low Allocation Rates for Buying Units in Early Years
If you were thinking of getting an ILP, your agent would have given you a document indicating the allocation rate. Here is an example.
Policy Year Premium allocation to mutual fund investment 1 15% 2 30% 3 50% 4-9 100% Thereafter 102%
Data Source: MoneySENSE
Simply put, what this means is that the following premiums are being used to pay for the distribution (i.e. commission payable to agent and profit for insurance company) of the policy.
| Policy Year | Premiums Paid Annually ($500 per month) |
Amount Paid to Insurer | Amount Used to Buy Units in Mutual Fund |
| 1 | $6,000 | $5,100 | $900 |
| 2 | $6,000 | $4,200 | $1,800 |
| 3 | $6,000 | $3,000 | $3,000 |
| 4 | $6,000 | - | $6,000 |
| 5 | $6,000 | - | $6,000 |
| Total | $30,000 | $12,300 | $17,200 |
Based on our illustration, $12,300 will be used to pay for the distribution cost for the policy while only $17,200 would be used to buy actual units in the mutual funds. Is this good for you, or your agent? Go figure.
“Hidden” Ongoing Charges
When you invest in a mutual fund, you incur management fees. This is the fee charged by the fund manager to investors of the fund. A typical annual fee charge would be about 1 to 1.5%.
We won’t go into the merits of requiring a fund manager when there are other lower cost options such as ETFs available. What you need to remember is that there will always be a fund manager charge involved when using a mutual fund.
On top of that, the ILPs could also charge an account maintenance fee. This could easily be another 1% of the total fund value. Let’s add more. How about the $10 monthly administrative charges? This translates into another 2%, based on the annual premium of $6,000 that we are using.
In total, you are easily looking at about 4% annual fee charges on an ongoing basis. We won’t be surprised if we are missing out on more hidden charges. You need to check your policies thoroughly to find out what fees are involved as each policy varies from one to another, even if they are from the same company.
| ♦ Investment-Linked Policies as an Investment | |
Using an ILP for investment purposes is a pretty bad idea. For an average year, you are already starting at about – 4%. For comparison purposes, the 10 year historical return of the STI ETF is about 9% while the risk-free return offered by CPF Special Account is up to 5%. |
| ♦ "Being Well Informed" is Your Friend |
|
We think it is important for consumers to be well educated before making financial decisions, especially ones that would have long-term impacts such as purchasing an ILP. We know many friends who have bought into ILPs during the early years of their careers and who have since terminated or are contemplating the termination of these policies at significant losses. Some of them have even bought from agents that are no longer in the industry. |
