Debunking The Myth Of Investment–linked Policies (ILP)

Why Investment-Linked Policies may not be a good idea

Insurance vs Investment

Let’s get the basics clear.

Insurance is when you pay a regular sum of money to an insurer in return for which they agree to pay out a pre-determined sum should something happen to you. If, touch wood, something goes wrong very soon after you take up the policy, the insurer has to pay you the full Sum Assured. But the longer your policy continues, the higher the eventual payout as bonuses are added to your Sum Assured*.

Investment is even more straightforward. You invest money in any instrument (stocks/shares, unit trusts, bonds) hoping that they increase in value. You make money if the value goes up and vice versa.

*When applicable – Whole Life policies add on bonuses. Term policies pay out a fixed Sum Assured.

The importance of specialisation

So far, so good. The problem starts when the two objectives get mixed together. It goes without saying that it is always better to specialise. If you want to invest, invest. The same goes for insurance. That way, your hard-earned money is working towards one single-minded objective. When you try to both at the same time, the value of your dollar starts to be diluted.

Why then do Investment-Linked Plans seem so common? Well, the reason for the popularity of ILPs is that financial institutions and advisors have pitched ILPs as offering you the best of both worlds. You are told that now you can protect yourself AND invest at the same time. While it sounds like your money is working twice as hard, the truth can potentially be the very opposite.

What is an ILP and how does it work?

• There are two parts to it – insurance and investment. Part of the premiums you pay goes toward paying for the insurance portion while the rest is invested in a basket of funds you choose (with advice from your financial planner)
• You decide on the Sum Assured. If anything happens to you at any stage of the policy, the Sum Assured is immediately paid out regardless of how much your investment portion is worth
• Take note of the most important aspect of an ILP – In the initial period of your policy, more of your premiums go towards servicing the insurance component. As the value of your investment grows closer to your Sum Assured, less is paid into the insurance component
• Only when your Sum Assured is covered by the value of your investments, do all of the premiums go into your investment component
• Whenever the value of your investment drops below the Sum Assured, part of your premiums will be diverted to your insurance policy. This will continue till the value of your investment reaches the Sum Assured (See chart below)

Let’s look at two possible policy options.

Option 1

• Your annual premium is $2,400 and sum assured is $200,000
• Let’s assume your investment grows at 4% p.a.
• At year 30, total premiums paid by you would be $72,000
• The total deductions (including insurance cost, distribution costs, expenses and charges) will be $58,000
• Your net investment value would be about $82,000
• If anything happens to you here, you either get the Sum Assured ($200,000) or the Investment value, whichever is higher

Option 2

• Your annual premium is $2,400 and sum assured is $12,000
• Your investment grows at 4% p.a.
• At year 30, total premiums paid by you would be $72,000
• The total deductions (including insurance cost, distribution costs, expenses and charges) will be $41,000
• Your net investment value would be about $99,000
• If anything happens to you here, you either get the Sum Assured ($12,000) or the Investment value, whichever is higher

So, is an ILP a good idea?

The numbers don’t seem to indicate that. At the end of 30 years, more than half your premiums have been eaten up by expenses. To cover all these costs and give you a healthy return, your investment component needs to work extra hard. You are probably better of separating the insurance and investment components. A term policy and an outright investment will give you superior value in the long run. A plan that initially seemed to offer the best of both the insurance and investment worlds, ironically works best only when you separate them.

By Isaac Anil

Isaac thinks life is what happens in between football matches. He is a born again dog lover who thinks cats are overrated. Having tried his hand at multiple vocations, he holds the same opinion about hard work. Till he can figure a way to beat the system, he relies on whiskey to get by.