My agent sold me an ILP. Should I keep it?

What is an ILP (Investment-Linked Policy)?

An Investment-Linked Policy (ILP) is a life insurance product that allows you to simultaneously insure and invest. This works by allowing you to invest through your life insurance plan. Aiming to achieve potentially higher returns, ILPs are usually marketed as an option for wealth accumulation.

ILPs come with a death and total permanent disability (TPD) benefit. Riders can also be added-on should you wish to enhance your coverage.

How do ILPs (Investment-Linked Policies) work?

Unlike other life insurance where all your premiums goes towards paying for your insurance coverage, ILPs are structured differently. When you buy an ILP, your premiums are taken to invest into various sub-funds. These sub-funds are managed by financial professionals. Apart from being used to buy your sub-funds, the premiums that you pay for your policy will also be used to pay insurer expenses, fees and administration costs.

There are two ways an ILP works: Front-end loading and Back-end loading.

Front-end loading ILP

In a front-end loading ILP, most of your premium payments for the first few years are used to cover the insurer’s expenses. Some of these insurer’s expenses include distribution and administrative fees. The remainder of premiums will then go towards the purchase of sub-fund units. Eventually, after the initial few years, a higher percentage of your premiums will then go towards the purchase of your sub-fund units.

An illustration for an ILP with a whole of life premium payment,

For a front-end loading ILP, your insurance coverage from the policy will be purchased using your units in the sub-fund. This will prevent you from having to pay separate premiums for the life insurance. For example,

You pay an ILP premium of $1,000 a year. 76% ($760) of your first year premiums goes towards insurer expenses, and 24% ($240) of premiums goes towards the purchase of sub-fund units.

Assuming the cost of a sub-fund unit (i.e. unit offer price) is $1, you will then be able to purchase 240 units with your premium.

The cost of your insurance coverage is $90.

The bid price (i.e. price at which your sub-units are sold) of your units is $0.90.

To pay for your $90 insurance coverage you will have to sell 100 units to cover the cost.

300-100 units = 100 units left. The cash value of your policy at the end of the first year is 200 units x $0.90 bid price = $180

With this we can see that while you paid $1,000 for the first year premiums of your ILP, only $180 is invested into your chosen sub-fund units in the first year of your policy.

Back-end loading ILP

Another type of ILP is one with a back-end loading. Similar to front-end loading ILPs, these type of ILPs will also use your premiums to pay for the insurer’s fees and expenses. However, unlike front-end loading ILPs, a back-end loading ILP uses 100 per cent of your premium to pay for these expenses from the beginning of your policy. The insurer’s distribution and administrative fees will then be covered by charges imposed when you sell your sub-fund units or surrender your ILP.

If you have an ILP but are unsure if an ILP is right for you, here are a few things to consider.

#1 ILPs come with investment risks

First consider what your intention was for buying an ILP – was it to invest or for the insurance coverage? While ILPs offer the potential for higher returns, do remember that ILPs also comes with risk as there is an element of investment in it. The cash value is also not guaranteed in an ILP and this will be affected if your sub-funds perform poorly.

If you are hesitant about the investment risks that your ILP subjects you to, then an ILP is probably not for you. For a second opinion on your existing ILPs, you may contact us here for a complimentary review.

#2 Insurance premiums in an ILP will increase as you get older

Did you know that the insurance premiums in your ILP will increase as you get older? This means that more of your premiums will go towards paying for your insurance coverage as you age, thus reducing the amount that goes towards your investment into sub-funds. An ILP thus runs the risk of having little to no cash value in your later years when more is needed to cover the cost of your protection portion.

With increased insurance premiums and the possibility of a reduced amount for investments in your later years, will your ILP still be able to achieve your objective of investing and insuring simultaneously? Or will the majority of your premiums paid go towards paying for your insurance coverage, leaving only a small amount for your investments?

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#3 Your purpose of getting an ILP

Lastly, we believe that investments and insurance should be kept separate. While agents may sell ILPs due to the potentially higher remuneration, ILPs may not always be suitable for an individual.

If you are looking for life protection, a term plan may be the better option as compared to an ILP. In our next article "ILP vs Term Life – Understanding the difference", we share the differences between the two plans and recommend which to choose to better suit your needs

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