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It’s no secret that insurance companies have come under a lot of public scrutiny for certain selling practices in years and decades past, particularly with some agents misrepresenting products in the name of closing larger deals and earning commissions. At the centre of this hailstorm of harsh words is the type of policy known as an investment-linked policy or ILP.
However, these policies are somewhat misunderstood. In part due to the misrepresentation and unethical sales practices we just mentioned, but partly also due to misunderstanding their purpose. Hopefully, after reading this, you will walk away with a new understanding.
Investment-linked policies are a unique type of insurance product that utilises the premiums paid by a client to provide both insurance and investment. Essentially, it gives a certain level of insurance coverage while also investing in "sub-funds" (i.e. investment funds managed by the insurance company's own fund managers.)
In theory, this works because the policyholder and their agent choose one or more sub-funds based on the policyholder’s risk tolerance, time horizon and overall investment objectives. The premiums are used to purchase “units” in these sub-funds. A certain number of these purchased units are sold to then cover the cost of the insurance component of the ILP.
This is where it gets interesting; there are two different ways by which ILPs are classified. The first way is based on the type of premium payment plan:
The second is far more critical and is arguably the leading cause of controversy and misunderstanding around ILPs (which we will elaborate on), and that is:
** Different ILPs provide wildly varying proportions of their insurance and investment components**
To be more specific:
For the purposes of this article, we are going to call these two classes of ILPs “Investment ILPs” and “Insurance ILPs”, respectively.
(Disclaimer: These are not official, technical terms and not one hundred per cent accurate descriptions, but we are using them purely for ease of reading and understanding.)
This leads directly into one of the reasons ILPs receive a lot of flak, which is that some (of course, not all) sellers, agents and brokers misrepresented what we have coined as an “Insurance ILP” as an “Investment ILP” and sold it to someone on that basis.
The scenario above leads to the buyer's unrealistic expectation of seeing the returns of an “Investment ILP” even though that is not what they purchased.
Why would they do this? Well, for a start, ILPs tend to be a high-premium product. It is not uncommon for a person to allot over $10,000 in annual premiums. Yet, despite this sum, an agent’s commission on an ILP can be up to a whopping 50% commission on the first year’s premium, not including any bonuses or internal incentive prizes within their company.
In the early 2000s, most ILPs were relatively unknown to many, so some insurance agents were saying whatever they had to say to make money, even if that meant somewhat overhyping this new product.
Don’t get us wrong, as "Insurance ILPs" have their uses as well! They can provide an appropriate level of protection while also giving you small bonuses and dividends with the correct investment allocation. The point is that you need to have a very clear understanding of which "type" of ILP it is that you are buying. To ensure this, ask your agent to clearly explain how much of your premium goes to protection (and for how much) and investments. In addition, make sure you are entirely comfortable with the answer.
"Investment ILPs", on the other hand, were essentially packaged as such because insurance companies wanted a way to be able to sell their sub-funds to their clients. These sub-funds are owned and run by the insurance company and managed by the fund managers in their investment division. However, largely due to regulatory constraints in many jurisdictions, these insurance companies needed to package them as insurance products.
The lovechild of a traditional Insurance ILP and a traditional investment; A modern ILP that allocates very little for insurance.
This product uses as little as 2 or 3 dollars per $1000 of premiums paid for the industry minimum death benefit coverage (which is: Upon death, the payout is 110% of Total Premiums Paid or Net Account Value, whichever is higher at the point of death).
As a result, a modern ILP throws more than 95% of the premiums into investing with the sole aim of wealth accumulation.
Fund management fees and the total expense ratios (TERs) of the sub-funds that the ILP is invested in are also essential to consider. Not all are necessarily high compared to other actively managed funds you could be investing in, such as unit trusts, but compared to passively managed index trackers like ETFs, they will be.
Even excluding the potential of underperforming against a benchmark over the long term, total expense differentials do add up. Over 25 years, a difference in costs as small as 1.0% a year on a lump sum would compound to more than 28% by the end of that period!
Ask your agent to tell you all the fees and show you where to find them on your policy proposal.
1) The "Great Misunderstanding" about ILPs is people being sold "Insurance ILPs" and made to believe that they were buying an "Investment ILP", leading to unrealistic expectations and vice versa
2) It is NOT to say that one form is unequivocally better than the other. Both types of ILP have their benefits. The problem arises when clients are not correctly made to understand which type they are buying
Now, with all that said about ILPs thus far, it’s essential to understand that they can potentially be of great benefit to you as the client, mainly if the underlying funds your money is being invested in do generate good returns.
For this, you should ask your agent to show you the Fund Factsheet for the underlying funds they recommend for your premium apportionment. As with any investment, do remember that past performance does not guarantee future results, which is, of course, something that a good professional will always tell you. Remember to focus on long-term results and ask if the sub-fund mandate suits not just your risk-reward profile but also your preferences (e.g. green or ESG investing.)
To us, the most significant benefit of an Investment ILP is having a regular and disciplined form of saving and investing in place, which gives you risk-appropriate market exposure and, if on a regular premium basis, applies the powerful investment principle of Dollar-Cost Averaging. (Of course, an ILP is not the only way to do this.)
In Dollar-Cost Averaging, you split your purchase into separate periodic transactions. You will commit a fixed amount of money to invest in a particular asset regularly. This aims to benefit from price volatility when you buy (since you buy more units when prices are weaker, and fewer when they are stronger) and takes away the human element of trying to time the market... on top of the already difficult decision on what to buy!
Let’s start with certain "perks" you may get when purchasing an ILP with an insurance company. They are great to have but never forget that insurance companies seek to profit from you, the customer. This is not in any way unreasonable at all, but it is worth remembering that nothing you get back from them is really "free"!
It is common for ILPs to come with any combination of the following:
Sign-on "Bonus": An incentive provided by the company for purchasing a policy with them. Example: A percentage (i.e. 125%) of your annual premium, paid over a period of the first few years of your policy term, contributed by the company itself. I.e. Paying a $10,000 annual premium would mean you “receive” (basically from what you paid) $12,500 paid in 3 to 5 annual instalments.
Loyalty "Bonus": The company provides a small annual bonus to your policy from, let’s say, the 10th year of your policy onwards. This is usually a small percentage of your annual premiums and is a “thank you” from the insurance company for your continuing business. “Loyalty” is extremely profitable for them, after all!
Premium Holiday "Privilege": It is not unusual for modern ILPs to come with a clause that allows you to, from a specific policy year onwards, take time off from paying your premiums without the entire policy lapsing. During this time, your money continues to be invested although no new premiums are added, which is helpful if you have a tough few years and find the premiums too much of a strain. (Once again, this is not “a gift” to you from the goodness of the insurance companies’ hearts, but it can come in useful, should the need arise!)
(Note that there is an opportunity cost here, and the absence of premiums will impact your policy value, as no new premiums are being invested during a premium holiday.)
Access to more “exclusive” funds: Certain funds are classified as “Accredited Investor”(AI) Funds, aka, “VIP Access only”. Insurance companies claim these funds to be managed by the very "best" fund managers and aim to generate more substantial returns than "retail funds".
However, you cannot invest in these funds as an individual unless you fulfil specific criteria ($2M net worth or $300,000 net annual income) plus, these funds usually require a substantial amount of capital for an individual investor (i.e. at least $100,000 single premium).
But through an ILP, you may potentially buy into these funds for as little as a few hundred dollars per month. Even if you do not fulfil the “Accredited Investor” criteria, the insurance company qualifies in this case as the AI on your behalf. (Previously, certain ILPs provided by companies such as AXA and Tokio Marine have allowed access to AI funds.)
Nowadays, ILPs are relatively flexible. If you are going through major milestones like purchasing a property or having a child, your coverage needs may increase.
If you are the owner of an ILP, in most cases, you can increase your insurance coverage by selling more units from your chosen sub-funds without impacting your premium amount and vice versa. You can also "fund switch" (that is, to change the underlying sub-funds your premiums are invested in) at any time during the policy term.
For most insurance companies in Singapore, you can do this for no added cost due to the Monetary Authority of Singapore regulations. Such regulations aim to prevent agents from a practice known as “churning”, which in the past was done by less scrupulous agents to generate sales commissions. Therefore fund switching would be purely for your benefit as the policyholder (though excessive switching is not a good strategy for long-term returns, even without those added costs.)
There are several reasons why ILPs have been given a bad reputation in years past, and it in large comes down to misunderstandings or misrepresentations by the selling party. However, there are many reasons why ILPs are potentially beneficial.
Those wishing to invest part of their savings/income towards financial goals could benefit from the extra savings and investment discipline (including DCA!) that comes with a long-term policy.
Lower fund management fees found elsewhere are irrelevant for those who do not invest at all!
The main takeaway: Thoroughly understand the policy you are buying before purchasing, read it through carefully with your trusted financial advisor, and clearly understand:
Take the time to ask your agent all the questions you need to feel comfortable - having a trusted adviser to talk to about it now and into the future is another one of the benefits!
INVESTMENT-LINKED POLICIES. COMPLETED ✅
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