Why you should not consider traditional Investment-Linked-Policy

Summary:

• Traditional ILP is like buying and renewing your term insurance yearly while investing through a single product

• Cost of insurance increases at an exponential rate and is not sustainable

• With the structure of ILP, you are unable to commit to a proper investment strategy hence resulting in a high chance of failure

With the craze behind investment-linked products [ILP] back during the early 2000s, it is not surprising to find individuals who constructed their financial portfolio using only traditional ILPs.

To make matters worse, this phenomenon is also common across families whose insurance coverage and investment exposure comes from nothing except for traditional ILPs.

In this article, we will be looking at the purpose behind an ILP followed by breakdown to examine the suitability of traditional ILP as both an insurance and investment instrument.

Hopefully by the end of this article, you will be well informed to decide for yourself if you’re one of the victims behind the ILP craze and identify the solutions to address this million-dollar problem.

The purpose of an ILP

An Investment Linked Product is as its name suggest, a product with both insurance and investment component. It provides the policyholder with both the coverage that he/she needs while at the same time assist him/her in the accumulation of wealth. But is that really the case?

Components of an ILP

Buying a traditional ILP is essentially the same as buying and renewing your insurance every year while also investing through a single product.

As the cost of insurance and the funds for investments are all derived from the same pool of fund, it is essential to understand how your funds are being utilized within the ILP itself: 

• Upon payment, 100% of your premiums are converted into investment units (incur bid-offer spread)

• Investment units will then be sold, and the amount will be used to finance for the respective costs

Because of the structure of a traditional ILP, the policy owner is subjected to higher investment costs as compared to direct investments and unsustainable insurance costs as compared to purchasing a term/whole-life insurance.

Premium Behavior of a Traditional ILP

To explain the above point, we will be examining a traditional ILP and breaking down its premium behavior.

For an ILP that has an annual premium of $1,500 (payable till age 99) and provides for a coverage of $150,000 for Death, Total Permanent Disability and Critical Illness, the premium behavior is as follows:

ILP as an insurance product

From the above chart, it is evident that in terms of providing for insurance coverage, an ILP is not a suitable product for its cost of insurance is increasing at an exponential rate.

In an event where you’re relying on the ILP to provide for your insurance needs, the cost of using term/whole-life insurance will be much cheaper given that it is calculated and fixed base on your age during application.

Should you need insurance coverage beyond the age of 55, the cost of an ILP is not economically justifiable for you to incorporate it into your financial plan.

ILP as an investment product

Apart from the cost considerations, an ILP is a completely inefficient investment instrument for two reasons

1. Inability to commit to an investment strategy due to the rising cost of insurance.

2. Forced selling instead of accumulating when the market is low

Let’s us examine each of the reason:

1) Inability to commit to an investment strategy due to the rising cost of insurance:

To properly mitigate the effects of market risks and achieve moderate long-term returns, you will have to invest a fixed amount on a regular schedule (a.k.a dollar-cost-averaging).

But because of the rising cost of insurance, the amount invested decreases over the years. This defeats the purpose of doing dollar-cost-averaging in the first place.

Furthermore, after age 55, a sensible investment strategy is one that enables you to retain the value of the funds that you had accumulated over the years to supplement your retirement planning.

However, because the cost of insurance is higher than the annual premiums, you will have to pay using the funds from your investment portfolio.

This will ultimately reduce your portfolio value which is counterproductive as you should be retaining the value of your investments to provide for your retirement plan.

2) Forced selling instead of accumulating when the market is low:

As the cost of insurances is fully paid from your investment portfolio, regardless of the market situation, you will have to sell off enough units to finance your cost of insurance.

This goes against the very principle of buying low and selling high as during a market downturn you will be selling low rather than buying low.

Conclusion

For an instrument that is created to provide for both insurance coverage and wealth accumulation options, we see that an ILP is an inefficient instrument to provide for either insurance coverage or investment returns. As such it is an invention that fell between two stools.

Should you need insurance coverage, it will be cheaper to lock in your cost of insurance by purchasing a whole-life or term insurance rather than renewing your insurance coverage through an ILP.

Should you need to invest, it will be better for you to just invest directly in the market rather than investing through an ILP. Direct investment is not only cheaper but also more efficient in the long run as the investor has full control over the funds within the investment account itself, unlike an ILP.

This enables the proper execution of investment strategies that will ultimately contribute to your long-term investment success.

Are you unsure if you are currently holding an investment-linked policy that may be silently ruining your finances? Do you feel like you are paying too much for insurance but do not know how to decrease your costs?

Get in touch with me and optimize your insurance portfolio today here!

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Disclaimer:

This article is meant to be the opinion of the author and is for information purposes only.

This article should not be seen as a financial advice

This advertisement has not been reviewed by the Monetary Authority of Singapore.