Navigating the Highs and Lows of Investment-linked Policies
Key points:
- As a hybrid product, ILPs offer the twin benefits of investment and life insurance protection.
- The success of an ILP depends on your investing skills. Unlike whole life policies that have a guaranteed cash value, the value of your sub-fund investments depends on your view of the financial market.
- Insurers offer a variety of sub-funds catering to different investment objectives, risk profiles and time horizons. You might even get access to exclusive funds, such as those available to institutional investors.
- Should your investment strategy change, free fund switches provide a low-cost method of adjusting your investments to match your the latest financial circumstances, risk appetite or investment outlook.
Interested to invest with ILPs?
Among investment products, none has divided opinion among investors as much as Investment-Linked Policies (ILPs), which is a hybrid product that combines insurance and investment.
While some like ILPs for the flexibility and multi-functionality that it provides, others believe that investment and insurance should always be kept separate and ILPs are a Frankenstein. This disagreement arose because ILPs are not for everyone. The decision on suitability involves recognising the pros and cons of ILPs – the product, types of ILPs, its features, and how it behaves in various market conditions.
What is an ILP? Just like horses, no two ILPs are alike
As a hybrid product, ILPs offer the twin benefits of investment and life insurance protection. The premiums paid are first used to pay for units of investment-linked funds of your choice (also known as: sub-funds). Some of these units are then sold to pay for insurance and other expenses of operating the ILP.
ILPs provide insurance protection in the event of death. Your beneficiaries will receive either: the sum assured or value of your sub-funds investment, depending on which pays more. The sum assured is typically fixed when you purchase the ILP, and the value of your sub-funds investment depends on financial markets.
Though sold by insurance companies, medical check-ups and underwriting are usually not required when purchasing ILPs. Such checks may however be required to add protection benefits such as total and permanent disability (TPD), accidental death, and cancer coverage.
ILPs can be categorised as:
- Single-premium ILPs – Where you pay a lump sum premium to buy units in a sub-fund, and life insurance protection. Single premium ILPs typically provide lower insurance protection than regular premium ILPs.
- Regular premium ILPs – Where you pay premiums on a regular basis such as monthly, quarterly, semi-annually or annually. By investing on a fixed schedule, it removes some of the emotional stress that comes with identifying the “right” time to invest.
ILPs can be purchased with cash, your Supplementary Retirement Scheme monies, or CPF savings (if the ILPs are included in the CPF Investment Scheme).
Don’t get caught off guard: Know how ILPs work
How does the investment portion of ILPs work
The success of an ILP depends on your investing skills. Unlike whole life policies that have a guaranteed cash value, the value of your sub-fund investments depends on the financial market.
Selecting a sub-fund: Policyholders get to choose from the insurer’s list, which has a variety catering to different investment objectives, risk profiles and time horizons. You might even get access to exclusive funds, such as those available to institutional investors.
When deciding which sub-fund to invest in, consider your expectations for the sub-fund’s future returns – historical performance should not be your only consideration. Sub-funds that offer the potential for higher returns come with higher risk of losses; and those with more a modest returns profile is comes with relatively lower risk.
Free switches between funds: Should your investment strategy change, free fund switches provide a low-cost method of adjusting your investments to match your the latest financial circumstances, risk appetite or investment outlook.
Do not go overboard. Note that most insurers offer a limited number of free switches and charge a nominal fee per switch thereafter.
Monitor the performance of your selected sub-funds through investment platforms such as Fund Search.
How does the insurance portion of ILPs work
Being investment-centric, most or all of your premiums will be used to purchase your sub-funds.
For most single premium policies, and premium top-ups, 100% of your premium is invested. This is why single premium ILPs typically provide lower insurance protection than regular premium ILPs.
For regular premium policies, the actual allocation depends on whether it has “front-end” or “back-end” loading. Regardless of which fee structure is used, the overall impact will be similar.
With front-end loading, most of the premiums will be used to pay for insurance coverage and the insurer’s costs in the first few years. Over time, this becomes $0 as the entire premium is used for investment.
Illustration of Front-end loading
| Policy year | Allocation to insurance costs and other charges | Allocation to sub-fund investment |
|---|---|---|
| 1 | 85% | 15% |
| 2 | 70% | 30% |
| 3 | 50% | 50% |
| 4-9 | 0% | 100% |
| Thereafter | 0% | 102% (Extra 2% provided by the insurer) |
Info source: MoneySense
With back-end loading, 100% of your premiums are used for investment. You pay for distribution and administration costs later, and only if the policy is surrendered (partially or fully) within a certain time period.
Mastering the ride - perks and risks of ILPs
What are some of the benefits and risks of ILPs?
| Perks | Risks |
|---|---|
| Higher potential returns vs other life insurance | Returns are not guaranteed |
| Flexibility to top up and withdraw investments | Investments may not keep up with rising insurance costs |
| Free fund switches |
Perks of ILPs
#1 Higher potential returns vs other life insurance policies
ILP sub-funds are invested in the financial market, and reap the direct gains and losses of market performance. In comparison, whole life and endowment plans invest in the insurer’s participating fund (known as ‘par fund’), where the investment strategy is determined by the insurer, and returns have an upper and lower limit.
Par fund performance is also affected by factors such as claims experience (whether this is more or less than anticipated) and expense levels
#2 Flexibility to top up and withdraw investments
Most ILPs allow policyholders to top up and withdraw their investments as and when they wish. This feature provides the flexibility to invest more in a particular sector or geographical region when your investment strategy calls for it.
#3 Free fund switches
Where switching between other investments involve redemption fees / subscription fees / initial sales charges, with ILPs you can switch between the sub-funds at zero cost.
Fund switches are useful if market conditions change, or if your chosen sub-funds are not performing as well as others. This allows you to adjust your investment strategy according to your financial circumstances, risk appetitive or investment outlook.
That said, it’s unlikely to have an unlimited number of free switches. So check with your Relationship Manager how many free switches you are allowed, and how much fees you would have to pay once you have maxed out your free fund switches.
Risks of ILPs
#1 Sub-fund returns are not guaranteed
In the event of death, your beneficiaries will receive either: the sum assured or value of your sub-funds investment, depending on which pays more. The sum assured is typically fixed when you purchase the ILP, and the value of your sub-funds investment depends on financial markets.
The potential returns from your ILPs depends on the value of your units when you sell it. So you know that you will get something back, but you do not know how much that will be.
#2 Investments may not keep up with rising insurance costs
Some of your sub-fund investments are sold to pay for insurance coverage, which rises with age. Over time, a bigger portion of your premiums will be used to pay for insurance coverage.
The worst case is the combination of high insurance coverage and a poorly-performing sub-fund. In this situation, the value of your sub-fund investments may not be enough to pay for the insurance coverage. Your options will then be to top-up your premium, or reduce your insurance coverage.
Adopting the right ILP for your investment style
Being a hybrid product, ILPs are arguably more complex than other whole life and endowment policies. Before signing up for an ILP, consider these:
- Can you take the risk of not having guaranteed returns?
- Does an ILP fit your investment objective and risk profile?
- What is the time horizon of your investment?
- Do you understand the fees and charges of the ILP?
With these answers, you can have a more fruitful discussion with your Relationship Manager on the suitability of ILPs for your wealth portfolio. And work out a plan to review your sub-fund investments regularly so it grows wealth for the next generation.
Interested in exploring ILPs for your investment portfolio?
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Disclaimers and Important Notice
This article is for information only and should not be relied upon as financial advice. Any views, opinions or recommendation expressed in this article does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
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