Insurance 101: Your Beginner’s Guide To Investment-Linked Plans (ILPs)

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Many of us do not buy insurance products because we are unfamiliar with the complex jargons and how insurance really help us. Yes, we might understand that we get paid a large sum upon death or diagnosis of the 37 critical illnesses. But not many of us understand how it works. This partly explains why we are so turned off when insurance agents approach us at MRT stations.

But, in reality, insurance can be easy to understand if someone helps us to unravel the mysterious financial jargons that are often used. And that is what we are going to do today with investment-linked policies (ILPs). ILPs are the most popular insurance product to be touted by insurance agents. As such, they are also one of the most bought insurance product among Singaporeans.

How do Investment-Linked Plans work?

Let’s start with the basics of how ILPs work. If you bought an ILP, you would be paying a regular premium every year. You can think of premium as your cost or your capital.

With the premium that you have paid, your insurer helps you set up an “investment account” to invest the premium. Since the insurer is involved as a middleman, they will charge some fees for setting up the account for you. So, with the money in your “investment account”, you can choose to invest the money in one or more funds in the universe of funds that have been selected by your insurer. You can even choose to switch between different funds, especially for the more financial savvy ones.

Source: Aviva

On top of the investment element, your insurer provides an insurance element. Unlike normal investments, an ILP gives you a sound of mind by promising to pay you a lump sum if you meet with a life ending situation. This is known as the sum assured, which is determined when you purchase your ILP. If you think that’s good, there are more to ILP that you will like.

Since your investments have the potential to grow larger than your sum assured, your sum assured has the potential to grow as well. This is unlike insurance products like term insurance or whole life insurance where there are none or limited potential to grow. This is a major selling point for ILPs for consumers like us. Who doesn’t want to get more insurance coverage for “free”?

Here’s what we do not like about Investment-Linked Plans

While ILPs might sound enticing, there are some things that we do not like about ILPs.

1. Bid-Ask Spread

The opportunity to switch between funds might sound like a gift from your insurer but it might be your greatest nightmare. Whenever you switch between funds, your insurer is charging you a fee without you knowing. This is built into the bid-ask spread of each fund in the universe of funds provided by your insurer.

If you are selling your holdings in one fund, you are selling it at the bid price, which is the lower price. When you are buying into another fund, you are buying at the ask price, which is the higher price. Unknowingly, you have lost some money when you switched between funds.

2. “No” premiums charged

You might have heard this from insurance agents, “Once your investments’ value exceeds your sum assured, you don’t have to pay premium anymore”. If you are thinking that there’s no such good deal in the world, you are right.

There is no such thing as no premiums payable. Yes, you do not have to fork out a single cent from your pocket if your investment value exceeds your sum assured. But here’s what your insurer does. First, they encash some of your fund at the bid price. The cash is then used to pay for the premium that you were supposed to pay from your pocket. While you did not have to pay from your pocket, it doesn’t mean that you aren’t paying premiums.

3. High commission for insurance agents

For most people, ILPs are complex insurance and investment products. Thus, they do not want to touch it. Insurers recognize this fact but they want to change it because ILPs are profitable for them. In order to encourage more people to buy ILPs, they offer a high commission to their insurance agents to sell ILPs. The commission can go as high as up to 50% of your first-year premium.

As a result, only a small portion of your premiums in the first few years are used for investment. This is known as a front-end loading, which is common in regular premium ILPs. A part of your premium is also used to pay for administrative costs of your insurer.

Policy year 1  15% 15% of the first year’s premium will be used to purchase units. 
Policy year 2 30% In the second year, 30% will be allocated to purchase units
Policy year 3 50% In the third year, 50% will be allocated to purchase units.
Policy years 4 – 9 100% From the fourth to ninth year, the full premium will be used to buy units.
Thereafter 102% From the tenth year onwards, 102% of the premium will buy units.

Source: MoneySense

Should I buy ILPs?

Most policyholders are being enticed into buying ILPs because of the promise of potential returns. Unfortunately, those returns are not guaranteed. Moreover, the returns are largely dependent on your investment choices in choosing which units to invest in. This requires a decent level of financial savviness that most policyholders do not possess. As a result, the investment returns of ILPs are usually abysmal. After all, if policyholders are financially savvy, they wouldn’t be relying on ILPs for investing. They would have chosen to invest their money on their own (which is the financially savvy thing to do).


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