A beginner’s guide to investment-linked policies
With investment-linked policies (ILPs), you get insurance coverage while also investing. What’s not to like? Yet, views on this product are split. Read on to find out what is ILP insurance, and how do ILPs work. Then, you’ll be in a better position to determine whether and why they suit your needs. Because the truth is, ILPs are not everyone’s cup of tea.
What is an ILP?
ILPs are sold by insurance firms and are designed to provide the dual benefits of insurance coverage and investment opportunities. They come in two forms:
- Single premium ILPs where you pay a lump sum once; and
- Regular premium ILPs where you make monthly payments.
How do ILPs work
The premiums you pay are used to do two things:
- Invest in unit trusts (also known as funds); and
- Purchase insurance coverage
Some of the units you purchase are then sold to pay for the costs of insurance and administrative charges.
There is a range of ILP-sub-funds to choose from, catering to different investment objectives, risk profiles and time horizons. You should refer to the insurer’s product sheet for the list of sub-funds that you can choose from.
Pros and Cons of ILPs
Just as there are two sides to a coin, here are what the sceptics and supporters say.
Some perks & risks of ILPs
|Higher potential returns||Returns are not guaranteed|
|Flexibility to adjust coverage||May have to reduce insurance coverage|
|May have to reduce insurance coveraget|
|Free fund switches|
Some Perks of ILPs
1. Higher potential returns
Because ILPs buy unit trusts which deal directly with the market, there is potential to make higher returns than other life insurance policies – if the funds do well. This is also dependent on the value of the funds when you choose to end your policy and redeem your investments.
2. Flexibility to adjust coverage
With ILPs, your units fund your insurance coverage. So, increasing your coverage comes down to selling more units to buy more insurance. The downside is that you’ll decrease your investment, but the upside is that you’re upping coverage without paying higher premiums.
3. Premium “breaks”
Usually, insurance policies get terminated if your payments lapse. But with ILPs, you can temporarily stop premium payments. This can be useful if you’re between jobs or you need to put your money towards other needs like a parent’s medical bills. During this premium “break”, the ILP will be kept alive by selling existing units to continue paying for insurance coverage.
4. Free fund switches
An advantage of investing through an ILP is the offer of free fund switches within the list of sub-funds offered by the insurance company. Usually, switching funds involve redemption fees (when you sell) and subscription fees/initial sales charge (when you buy).
Fund switches are useful if market conditions change, if your chosen sub-funds are not performing as well as others, or if your personal risk appetite changes.
But before you do that, check with the ILP distributor how many free switches you are allowed. And how much switching fees you will have to pay, once you’ve maxed out the maximum number of fund switches.
Some Risks of ILPs
1. Returns are not guaranteed
Unlike participating whole life plans which use most of your premiums for insurance coverage and some parts for investments, ILPs purchase funds that dabble in the market. While ILPs project higher returns, they do not guarantee that rate. What you end up with when you surrender your policy depends on what the units are worth at that time. In short, the investment risk is borne by the policyholder.
2. May have to reduce insurance coverage
The cost of insurance rises with age. As we get older, our risk of developing diseases and conditions also increase. Over time, it may be possible that the units bought with your premiums may no longer cover your insurance cost. You may then end up with little or none put into investments. To maintain the investments, some then resort to reducing insurance coverage.
It is up to you to adjust the balance between the investment and insurance (protection) elements in your plan to achieve the outcome that you prefer. But of course, the more insurance (protection) you require, the more investment units you have to sell to pay for the insurance premium.
So, are ILPs suitable for me?
Before you sign up for an ILP, consider these factors:
- Can you take the risk of not having a guaranteed return rate?
- Does an ILP fit your investment objectives and risk profile?
- What’s the time horizon of your investment?
If you do have an ILP, remember to regularly assess your costs and benefits, and review your plan with your wealth planning manager at every major life stage.
To find out more, talk to our Wealth Planning Managers