Recently, while I was on a grocery run, I was stopped by a lady who acted really pitiful and requested
2-minutes of my time to help her complete a survey and hit her quota of the day. Feeling a little kind that evening, I gave in to her request. Turns out, the
2-minutes became 20, and the so-called survey was actually a one-to-one date with an insurance agent. A brief flashback of similar occurrences hit me, and I was sitting there wondering how I, again fell into such a ploy. I made yet another mental note of never to fall for such
traps again.
I sat there planning my great escape while the agent went on to ask questions to understand my financial situation. I told her I dabbled a little in stocks, and she immediately recommended me an Investment-Linked Plan (ILP).
I'm sure many of you who have spoken to an insurance agent before have heard of the product. ILPs have been aggressively pushed by insurance companies to consumers, and I'm sure many of you heard a lot of talk about the product. Truth be told, I sat there knowing I wasn't interested, and I was sorry I wasted the poor lady's time, as well as mine (I must say she was pleasant to the eyes though, haha).
What are Investment-Linked Policies?
As its name suggests, it is an insurance policy that provides the policyholder the ability to also invest. Simply put, the policy is the "
best of both worlds". Yet ironically, it feels more like a "
jack of both trades, master of none".
How the product works is the premiums paid by the policyholder is used to acquire units in a fund of their choosing. Some of these units are then sold off, to pay for the insurance component of the policy.
The marketed "GOOD" side of ILPs
Taking a look at the brochure I was provided, I was sold that there were tons of benefits of the plan:
1) Flexibility to increase or reduce your regular premium anytime
There are certain months where we feel financial tight
(your other half's birthday, anniversary, etc), or other months where we have spare cash sitting around
(year end bonuses, etc), this allows us to increase or reduce our
"investment" anytime. You may even take "
premium holidays" without compromising your insurance coverage.
Note: The brochure I was provided stated that this was allowed only after premiums have been paid for the first two policy years. Non-payments during the first two policy years will terminate the policy automatically.
2) Allow you to invest in a range of funds
As a policyholder, you can build your own financial portfolio by allocating your money in a range of funds provided by the insurer. I was also sold that you could switch funds at anytime, subjected to the bid/offer spread of the funds.
3) Adjust your coverage based on your priorities
Since the units in the fund of your choice is sold off to pay for the insurance component of the policy, you can adjust your coverage depending on your priority on the weight-age of investment-insurance.
4) Enhance your protection cover with optional riders
You can even customize your plan by adding on optional riders such as critical illness, disability, and terminal illness. In the event you claim for the aforementioned, your coverage and investment values from your basic plan will remain unaffected.
What is not mentioned in their marketing
As with all financial products, these factors are usually quickly brushed through, or are not even mentioned to the consumers:
1) Low Allocation Rates
If you are getting an ILP, request for the document that indicates the allocation rate of your policy. Below is an example:
What this means is that for Year 1 of the policy, only 15% of the premium paid by the policyholder goes to investing in the fund of their choice. The remaining 85% is used to pay the insurer for the insurance component of the policy. Thereafter, as the years progress, more of the premium paid is apportioned to the investment component. Of course, this is just an example, and you can check with your agent if you intend to get an ILP.
2) Small, Substantial Costs
i) Bid/Offer Spreads
Similar to stocks, mutual funds that you decide to invest in has bid/offer spreads. Based on the Funds Fact Sheets provided to me, this spread is typically 5.0%. Compare this to the tick size for equities listed on the SGX, the biggest spread you can pay when you purchase a stock is 2.5% (Price Range: 0.20 to below 1.00):
ii) Fund Management Fee
Unlike stocks, which your get charged a one-time commission for buying/selling, when investing in a mutual fund, you will incur a management fee. These are fees charged by the fund manager to investors of the fund. The typical management fee is around 1.5% per annum.
iii) Other Fees Not Made Known to Me
Besides the above mentioned costs, I believe that there should be more "fees" and "charges" that a policyholder will incur. Of course, since I am not able to validate this point, this will be kept out of my analysis.
How does ILP compare to managing your own investments?
This is what we have all been waiting for.. So how much are you losing out when you get an ILP compared to actively investing by yourself? We will let the numbers do the talking.
Taking only the management fee into consideration, and selecting the best performing fund from the Fact Sheet provided to me, below is the comparison against the performance of the SPDR STI ETF:
|
Best Performing Fund
|
|
Annualized Return Since
Inception (Net Fees)
|
6.03% (as of 30 June 2017)
|
7.27% (as of 30 June 2017)
|
Note: Not all funds might provide market beating returns.
To give a better picture in terms of numbers, let's assume a person invests $6,000 a year for the next 40 years. Based on the annualized returns above, these are the results:
Years
|
Best Performing Fund
|
SPDR STI ETF
|
Percentage Difference
|
1
|
$6,000.00
|
$6,000.00
|
|
2
|
$12,361.80
|
$12,436.20
|
0.60%
|
3
|
$19,107.22
|
$19,340.31
|
1.22%
|
4
|
$26,259.38
|
$26,746.35
|
1.85%
|
5
|
$33,842.82
|
$34,690.81
|
2.51%
|
10
|
$79,196.28
|
$83,963.46
|
6.02%
|
20
|
$221,426.66
|
$253,347.74
|
14.42%
|
30
|
$476,861.42
|
$595,056.35
|
24.79%
|
40
|
$935,602.48
|
$1,284,404.68
|
37.28%
|
Note: This is not factoring in the selling of fund units in the ILP to pay for the insurance component of the policy. The difference would be even more substantial if included.
By Year 40 of investment, the portfolio made up of just the SPDR STI ETF would be a WHOOPING
37.28% more in value compared to the ILP fund. With this difference you could have gotten a much more comprehensive and value insurance policy compared to the insurance component of an ILP.
One last negative about ILP
All funds have their ups and downs. In the event your fund is not performing well, more of your units will have to be sold to pay for the insurance component of your ILP. For example, your insurance component costs $100. With a bid price of $1.00, you would have to sell 100 units in your fund. However, if your fund is not performing well, and has a bid price of $0.90, you would have to instead sell 111 units to pay for this insurance component.
What is the solution to ILP?
You might be screaming this question for awhile now. My personal opinion is to not mix your investments with your insurance coverage. It does not take much effort to open an account with a broker and dollar cost average the SPDR STI ETF (most brokers even have monthly investment plans on the SPDR STI ETF - although the do charge a higher commission).
Starting with SPDR STI ETF might even be a stepping stone into the world of investments for you. Doing it yourself and understanding how your money grow can provide a huge sense of achievement.
Note: This is my personal take on Investment-Linked Policies. Of course some people would rather purchase an ILP because it is fuss-free and it provides the "best of both worlds" scenario for them. Everyone has something that works for them, you just need to know what works for you.
