Why ILPs Are So Misunderstood

I did some research for this article by checking out various online forums and gauging the online sentiment on this very highly controversial product – Investment-Linked Plans or ILPs for short.

Here are some screenshots:

What I am going to write next is probably going to put me within a small minority. Now if you sincerely believe that ILP is not the best choice for you, then please DO NOT BUY.

Someone who is financially savvy and educated on investment will be unlikely to ever buy an ILP.

From MoneySense website:
Investment-linked insurance policies (ILPs) have both life insurance and investment components. Your premiums are used to pay for units in investment–linked sub-fund(s) of your choice. Some of the units you buy are then sold to pay for insurance and other charges, while the rest remain invested.

ILPs provide insurance protection in the event of death or total and permanent disability (TPD), if included. Depending on the policy, the death or TPD benefit may comprise the higher of the sum assured or value of ILP units or some combination of the sum assured and the value of ILP units. How much is paid depends on the value of the units of the sub-fund at the time.

This article is not to convince you to buy ILPs.

Instead I want to shed some light into this product which has been criticised so badly.

Below I share some of the common perceptions people have on ILPs which I added with my own clarifications.

What People Say #1: Buy Term Insurance. Invest The Rest.

This above statement is commonly thrown around. You might even have heard it before. But people who often throw this statement around are usually the financially savvy and have educated themselves on investment.

I agree with this statement – seeing that I like to consider myself as financially savvy and have a generally solid understanding on how various investment instruments work.

Here we mention term insurance. The word term is originating from the fact that it is for a SPECIFIC period of time. The right way to treat term insurance is as an expense.

What it does is provide protection for a certain period of time. There is no cash value at the end of the term.

Term insurance is much cheaper than whole life insurance.

That’s why there is the added sentence of “Invest the rest.” Here it encourages you to set aside the amount that you saved from buying cheaper term insurance into your own investments.

This is all fine and good. Right?

But as a financial planner who is on the ground everyday who used to be a full-time employee as well, this statement is too idealistic.

The truth is majority of the people I’ve met are busy professionals – they have to take care of so many things at work. And after work, they have to take care of family.

To be honest – these busy professionals have absolutely no time to start to learn investment.

There are many reasons that are given: Lack of time, procrastination, no interest or just pure laziness.

There is this term called a cognitive miser. Cognitive miser is a social psychology theory that suggests that humans, valuing their mental processing resources, find different ways to save time and effort when negotiating the social world.

We are all cognitive misers. We overestimate our ability in “invest the rest”. What happens is the money saved (from cheap term insurance) is not going to be invested – instead what’s likely to happen is that we use that as a reason to spend more.

What People Say #2: Protection & Investment Should Be Separated

Again, this statement is similar to the “Buy term and invest the rest.”

This statement also has the same underlying assumption – we can all be savvy financial wizards that knows how the various investment instruments work.

If you are savvy and clearly understand the ups / downs of investments, then DO NOT buy ILPs.

But what if you are not?

What if you are just a normal average salaried employee who wants to make sure he or she has adequate protection?

Treat ILP as a financial tool if you are unsure of how to invest. You can consider it as a way to conduct forced savings.

ILP on the other hand should be treated as both protection & investment – with a higher weightage on protection.

Investing the rest – with no knowledge – will only make you incur losses.

What People Say #3: ILPs Has Too Many Layers of Fees

For this case, we need to compare apple to apple.

In this case, we need to compare ILP with a traditional whole life plan.

When you say ILPs has too many fees, it doesn’t mean that whole life plan doesn’t has the same fees.

The problem is an ILP is so transparent with its fees that it contributes to its lousy reputation. With ILPs, you can easily obtain the charges and costs incurred.

ILP has more transparency in the sense that you know exactly the number of units and what the value of the units has at any one point in time.

For whole life plan, there is no information provided regarding the fees and charges. The most you can see is that there isn’t any policy value within the first 2 years.

With whole life plans, the Surrender Value, Maturity Value are big uncertainties, affected by what would the Terminal Bonus (non-guaranteed bonus portion in whole life plan) would be.

Even then, for whole life plan – if the participating funds does well & bonus is cut, we can’t do anything.

With whole life plan, there is no such things as partial withdrawal or premium holidays.

If you need to take money out from a whole life plan, you are basically taking a loan with interest.

For ILP, you can perform partial withdrawals without any fees. Premium holidays allows you to stop paying premiums and yet the same coverage can STILL continue. This is done by using up the accumulated policy value.

What People Say #4: ILPs Are Very Risky

Risk has different definitions for different people.

Is it risky to know everything? For some people, Yes it is RISKY. Because if it fails, you can only blame yourself. There is no one else to shift the blame to.

For example, an ILP by being transparent, allows you to choose which funds to invest in.

While for a traditional whole life plan, you just take whichever returns the insurance company is giving you. For example, you wouldn’t know if your whole life plan has investments in oil & gas industries and suffered a big loss that year.

What will happen is usually the insurance company will use savings from the good years to pad the returns to make up for the bad years.

With an ILP, you can also get access to funds that are exclusively available to accredited investors only. Usually these funds have a long and proven track record and usually managed by experienced fund managers.

Is this good or bad? On one hand, you need not have to cough up huge sums to gain access to these funds.

On the other hand, there are also various fees applicable.

Some people choose to enter into an investment with eyes wide open or eyes closed tightly.

What People Say #5: Agents are out to earn fat commissions from selling ILPs

Ah. This is another common refrain. To tell you the truth, MAS has tightened the guidelines for commission tiers since the beginning of 2016. (now pushed to 2017)

MAS has mandated insurance companies NOT to give out large commissions within the first 2 years – instead to spread out commissions over 5 years.

It is obvious that MAS wants all financial planners to provide continuous service and not just to hit, close and run.

In actual fact, almost all products (including term insurance) have similar commission structures as ILP.

Insurance companies also do not want to be seen as mostly just promoting ILPs. As a company, they prefer to sell a wide range of diversified products.

Conclusion

The problem is most people are not knowledgeable enough to invest. Even if they knew, they delay to invest. A lot of them actually procrastinate on gaining the knowledge to invest.

The issue is a lack of confidence.

And they are also educated by the Internet – which is not exactly a paradigm of factual information.

Different profiles suit different risk appetites. This results in different investment decisions.

We are not sure whether the forums that we read online – will it help OR overwhelm us? Are there hidden agendas existing?

I cannot say ALL ILPs are bad simply because I have clients who are happy that they bought ILPs.

Did they make money? Some made some, some broke-even and some lost.

(Doesn’t that sound like an outcome from any other investment strategy?)

But they are glad that there is this plan which has cash value accumulated and provided them with an additional source of savings.

Because the alternative was they could have easily spent it or maybe lost it into an unknown investment instrument that they are not familiar with.

Whatever your decision is, there is always the urgency of time.

You can’t plan for retirement at age 50 – it becomes too late.

At age 40, it is still possible but opportunity costs are higher.

The best is to act when you are still young – either in your late 20s or early 30s.

Also, ILPs are better suited for consumers with a longer investment horizon to ride out market fluctuations and defray initial costs which can seriously limit short term potential returns.

There may be other investment options that could better suit your needs.

If you wish to read up more, you can go here: http://www.moneysense.gov.sg/Understanding-Financial-Products/Insurance/Types-of-Insurance/Life-insurance/Types-of-Life-Insurance/Investment-Linked-Insurance-Policies.aspx

If you choose to do your own research, I recommend you visit http://www.comparefirst.sg to check out the various products across different insurance companies.

In case you are wondering, I do own an ILP. The main reason was because this particular ILP gave me access to certain funds that were otherwise inaccessible.

My personal belief is I will not sell something that I don’t own and experience for myself. If you are keen to know more, feel free to contact me.