You may have read from various forums, Facebook groups, or even heard your friends saying that getting an investment-linked policy in Singapore is bad. Well, it could be bad if you get the wrong type.
However, if you take your time to properly look for the right one, it is possible to get a policy that provides returns that are comparable to other self-managed investment tools.
But before you get “convinced” by financial advisors that investment-linked policies are actually good for you, it’s best to understand how investment-linked policies work so that you can make an educated decision.
What is an investment-linked policy?
An investment-linked policy or investment-linked insurance policies (ILP) are a two-way financial product offered in Singapore. The premiums you make meets both your insurance and investment needs. The investment part of an ILP covers both the insurance and returns aspects of your policy.
The hybrid nature of this policy is what makes it relatively more complicated and risky to purchase.
Here’s a fun fact:
ILPs are actually a life insurance product. They were created to offer more flexibility to consumers as compared to the typical whole life plan. Your money is invested and the policy is expected to mature at a specified date – just like a whole life plan.
The growth you earn is supposed to be your sum assured.
However, with the ways that ILPs are marketed now, it’s regarded as an investment rather than a life insurance policy. It can, however, complement your investment portfolio if you choose the right one.
How does an ILP work?
ILPs are investment-centric; they invest in unit trusts. Most of the premiums go in buying investment units for the ILP sub-funds you want to invest into under the policy. Your premiums will also pay for insurer expenses, fees, and administrative costs.
You may need to either pay these costs in full or partially for the first few years of the ILP through front-end or back-end loading. More on these later.
Types of Investment-Linked Policies
There are two main types of ILPs. You need to understand the difference between investment-based and insurance-based ILPs.
Investment-Based vs Insurance-Based
This is where many misconceptions of ILPs exist. It’s important to understand these main differences before proceeding.
Traditionally, insurers offer insurance-based ILPs. This is because consumers find whole life insurance policies not worth the amount they spend due to a lesser cash value received as compared to their premiums paid. Thus, investment-linked plans were born.
These ILPs allow you to control the insurance portion and the investment portion of your policy. Meaning that if you need more insurance coverage, you can simply opt for more insurance coverage and reduce your investment funds.
However, the bad thing about these ILPs is that it mixes both insurance and investments together – which is never a good idea. A clear and distinct separation should be made so that you understand where your money is going into.
That’s why a newer type of ILP currently exists in the market, investment-based ILPs.
With the clear distinction demanded from consumers, insurers came up with the investment-based ILP so that your investments can be directed to purchasing more unit funds.
Although these policies mention a death and TPD benefit, it’s not the same as what insurance policies and insurance-based policies offer. Instead of providing you a sum assured (usually more than the premiums you pay), they return 101% of your paid premiums.
This means the insurance company has little to no need to funnel your premiums into providing you with an assured sum and you get more investment unit funds instead. With more unit funds, you will accumulate more wealth and faster than insurance-based ILPs.
Next, you will have to choose how you would like to make your premium payments.
With this type, you can purchase investment units in the ILP sub-fund with a lump-sum premium payment. Single-Premium ILPs have shown to provide lower insurance protection than the regular kind.
Regular-premium ILPs gives you the flexibility to pay your premium amount in installments, be it monthly or yearly. It also permits you to tailor your insurance protection.
Front-end uses most of your premium payments to cover the insurer’s expenses, like distribution and administrative fees. You will still have some of your premium to buy units in a fund or sub-fund.
It’s only after a few years that all of your premiums will solely be used in buying ILP sub-fund units. But this event takes place only after the insurer has taken its share.
Back-end loading also uses your premium to cover the insurer’s fees and expenses. The difference for back-end loading is that the full premiums are used to purchase units at the beginning. Fees and sales charges are deducted monthly through the sale of the units in the fund or sub-funds.
ILPs vs Whole Life Policies
ILPs may seem quite similar to a whole life plan with a participating fund, but it is quite different. The distinguishing factor is that ILPs are investment-focused with added life coverage.
In contrast, whole life plans are insurance-focused with the option of a cash payout at a later age that could be used to supplement your retirement.
ILPs invest in unit trusts funds or sub-funds to give you leverage according to your risk classification and investment objectives. In contrast, whole life policies’ cash value is dependent on the participating fund of the insurance company which ranges between 3.25% to 4.75%.
You, as a consumer, have a choice of choosing the funds, usually with advice from a financial advisor. Your financial advisor will explain to you how equity funds and geographically-specialised funds work. It works best if you are more aware and do your bit of research in comparing the two.
It’s also safer to opt for a more straightforward life insurance product over an ILP if you do not have sufficient knowledge and risk perception. However, if you’re keen to understand more about how ILP can help you grow your wealth, continue reading on.
Since an ILP works as a hybrid, let’s understand both the investment and insurance portions.
The Investment Segment
The funds or sub-funds you choose determines the investment strategy for your ILP.
The insurer is going to provide you with an array of sub-funds to choose from for your policy. You have the choice to decide your investment strategy based on your risk or your advisor could do that for you.
Here are some factors you should consider when choosing a sub-fund;
- Choose what suits your investment motives and time scope, whether you should choose one or more sub-funds.
- Don’t base your scrutiny only on the historical performance of the sub-fund. You must also be comfortable with its risks and if they are conforming to your risk profile.
- Some sub-funds may offer higher potential returns but have an increased risk of financial losses. Others, such as cash sub-funds, may have lower potential and turn over moderate returns with lower risks.
- The Central Provident Fund (CPF) assigns a risk classification along with its sub-funds. You may not want to consider it as it is merely a general guide. It doesn’t indicate clearly if the sub-fund is suitable for you.
ILPs also allow fund switching. It means you can move your money from one sub-fund to another. This feature is most helpful when your financial situation changes, or your risk capacity with the current sub-fund becomes unsuitable.
Depending on the insurer, some ILPS offer free fund switching, whereas others offer a limited number of times you can switch. A nominal fee may be charged for every switch after an over-limit.
It’d be best to check the number of free switches you are entitled to and the cost involved in switching.
The Insurance Segment
It’s natural for the risk of death, total permanent disability, and terminal illness to increase with age.
In the event of death, total permanent disability, and terminal illness, insurance-based ILPs will payout either the sum assured or the value of your account units, whichever is higher.
Incidentally, for insurance-based ILPs with a sum assured, the cost of insurance also increases year on year while you pay a constant monthly premium throughout the policy’s life.
It means selling more investment units to pay for the insurance costs. This leads to fewer units to accrue cash value for endowment under the policy as you need to sell more units to pay for the insurance premiums.
Your units’ value may not be sufficient to pay the insurance charges if you have high insurance coverage and a poor performing sub-fund. In such a case, you may need to top up either your premium or reduce the sum insured.
For investment-based ILPs, there is no sum assured involved. Instead, you either receive 101% of your premiums paid or the value of your account units, whichever is higher.
As there is technically no insurance coverage provided, you should supplement your protection through other forms of insurance.
Advantages of Buying an ILP
Flexibility To Adjust Insurance Coverage
For whole life and par policies, you cannot increase or decrease your insurance coverage after buying it.
However, with regular premium insurance-based ILPs, you have the leeway to adjust your premiums while maintaining the same assured sum.
For instance, you buy your ILP as a student and work part-time. Later, when you become a full-timer with a firm with excellent group insurance, they can cover most of your life insurance needs. You can then choose to lower your policy’s life insurance coverage and move more of your premiums for wealth accumulation.
Ease of Investing
ILPs, similar to robo advisors, is an excellent tool for someone with no experience, time, or interest in investing to kickstart their investment journey.
By investing in an investment-based ILP, one can invest in unit trusts without worrying about the type of funds to choose from while having a potentially higher return compared to an endowment or whole life insurance plan.
Furthermore, your financial advisor will be the one managing everything for you. Thus, it’s pretty fuss-free for someone who’s not financially savvy but wants to start making your money work for you.
One of the most significant advantages of buying an ILP will be the bonuses that come with the first year’s payment. The bonuses will act as a buffer for market drops and a booster for market booms. This will help to protect the main investment from principal losses while giving further boosts to the principal amount during market gains.
Cons of ILPs
Similar to most investment tools, the returns from an ILP depend on the market conditions. An economic plunge will yield lower returns, while an economic boon will ensure better returns.
ILPs should not be your sole investment asset mainly because they do not have any guaranteed cash values. You should not invest all your funds into one ILP but back it up with a mix of other investment products such as bond funds, fixed deposits, and cash savings, to name a few.
The Age Factor
The format of insurance-based ILP is such that you pay insurance charges by selling investment units. The reality is the cost of insurance will increase as you age. As the years go by, the sub-fund units will no longer be adequate to pay for the insurance cost.
In this scenario, you can resort to lower your insurance coverage or raise your premiums to uphold your life insurance coverage.
This wouldn’t be much of an issue if you were to get an investment-based policy.
Investor Suitability Factor
ILPs may not be fit for older investors or those with a shorter investment range. As revealed earlier, ILPs are volatile.
For instance, if you are 55 and nearing the retirement age of 65, it may not be wise to opt for an ILP. That is because you won’t have enough time to recover, considering that an ILP depends on market conditions.
If you get an insurance-based ILP, your life insurance portion will also demand more premiums as you age.
Complex Nature Of ILP
The layers of complexity in an ILP come from choosing the sub-funds and planning for greater returns – similar to self-managed investments. It is sensible to seek a financial advisor’s help to take you through the product and explain the model in detail.
Questions to Ask When Considering an ILP
- What are your goals?
Your goals, both financial and investment, largely depend on your current financial standing and age.
If you don’t have dependents, you can benefit more from an investment fund designed in parallel with the financial goals set. ILPs are more investment-centric and may suit your needs. They have higher investment risk, but returns can also be potentially higher.
In contrast, whole life or term life insurance plans will be more profitable if insurance is your primary goal. You may want to choose policies that cover your family and loved ones.
- What is your risk appetite?
As with many investment tools, ILPs come with risks as it does not provide guaranteed cash returns. The performance of the investment portion defines the value of an ILP.
If you aim for high growth in your investments, you may want to do the analysis first. It’d be wise to engage professional advisors to ensure the funds you are investing in belong to an asset group that can boost your returns.
Another vital risk factor is your age. Younger investors have more time to choose more dynamic investment funds to fuel their goals.
- What’s your time horizon?
The essence of insurance products is to cover unforeseen events primarily, and ILPs are no exception. They generally require to set a time duration before you realise returns.
It’d be best to discuss with an expert while planning your ILP. They will help set a time horizon for your investment and chalk out your investment goals as an investor.
For instance, you are 35 and have plans to retire by 55. It means the time horizon for your retirement planning approach would be 20 years.
Besides the time horizon, you will also need to balance your insurance needs and the premium you can manage based on your life stages as well.
Things to Note Before Buying an ILP
ILPs may not be right for everyone. Consider the following before buying an ILP.
- You must be clear with your priority. Do you want to amass wealth? Or are you only focused on getting insurance protection? If it is the latter, a simple life insurance plan may be more feasible.
- If you can handle variable returns depending on market conditions, you may very well be able to take an ILP. In contrast, if you want guaranteed returns, you may consider capital guaranteed endowment plans.
- What is the minimum investment period and do they offer premium holidays? This is important to know as ILPs can be a long-term commitment and you must also furnish the premiums even if you no longer earn.
- Do they offer top-ups and partial withdrawals on an ad-hoc basis? This could be useful if you need the liquidity or want to give your investments a boost.
- Time horizon is a vital factor. ILPs are more fitting for people with a longer investment horizon.
- Compare investing through an ILP against other investment opportunities. The sub-fund could also be available as a unit trust (no insurance coverage charges) in some cases.
- Some ILPs are more investment-centric, while others may allow you to set the coverage level. You will need to pay for more units leaving fewer for investment in case of more insurance coverage.
So… Who Should Get Investment-Linked Policies?
You should get an investment-linked policy if you are either of the following:
- You’re not financially savvy
- Do not have the time to manage your own investments actively
- Do not have an interest in investments but want to grow your money
This is because your financial advisor wholly manages investment-linked policies and all you have to do is continue making regular investments into your policy.
Whatever insurance plans or investment plans you choose, it should depend on your personal goals. Your investment portfolio should be in line with your unique financial goals, which is the most crucial factor to remember.
ILPs require careful research. Evaluate your risk tolerance and financial commitment you can take on first.
We would encourage you to take the time to assess if your ILP can benefit you until it’s mature. We generally do not recommend insurance-based policies because of the insurance portion involved.
If you want to get an investment-linked policy, we would generally recommend an investment-based ILP as more of your premiums are funnelled into purchasing unit funds.
As many say, it’s always wise to keep your insurance and investments separate.
We have some articles compiling the various investment-linked policies from the different insurers in Singapore. The list is not conclusive as we’re still working on them, but do check out the articles here:
No matter what research you do, you may want to discuss with close ones and, more importantly, talk with an unbiased financial advisor to review your long-term objectives.