STARTER GUIDE TO FINANCIAL PLANNING
Let’s Discuss The Good and Bad Of Investment-Linked Policy
Investment-linked policies were the hottest product when it hit the market during the 90s. Consumers on a regular basis were purchasing it. It seems like the best invention ever in the insurance industry.
To even boost up the popularity, it was possible to purchase them via your CPF monies. Thus it was made more possible for average consumers to own them.
It was a perfect choice as it involves both insurance and investment. It is a 2 in 1 kind of product. Who would not want to buy 2 things for the price of one?
Investment-linked Policy (ILP) Explained
Let’s come back to the basics. An Investment-linked policy (ILP) is an insurance product; therefore it is produced by an insurance company. Which means it is insuring the life assured when a certain unfortunate event occurs to him/her. Thus that is one function of an ILP.
The next function would be the investment component. If you purchase an ILP, you are able to place your premiums into sub-funds. Fund houses provide the sub-funds and they are the ones who will assist you in investing your money.
The question is how do both functions work together? Or how are they able to exist into one policy?
The Good
By looking at the picture above, you are able to see where there are several stages. Firstly, you would be paying premiums regularly and all of the money will be used in buying the sub-funds. The number of units that you will own would be determined by the price of the sub-funds at that stage.
As the premiums would be level throughout the duration of the policy, the number of units purchased would be determined by the price of the sub-funds at that particular buying timing. This is when the term “buy low, sell high” comes into place.
Therefore over time, you will slowly own more and more units. For you, as the policyholder to get a positive return from your investment, your Net Asset Value (NAV) of the sub-funds when you want to redeem (sell) must be higher than your NAV when you purchase (buy).
As a result, the more units you own, the higher the chances you are able to get a very high positive return. Therefore, you would think that you would definitely buy more and more units as time passes by and you would eventually earn a profit. But then again, is it really all that easy?
The Bad
Here comes the bad news. Like what is mentioned above, an ILP does have an insurance portion. And that insurance portion has to be supplied with money as well in order for that function to exist.
Since majority or all of the money is used to buy the units, the money for the insurance portion will be coming from the units. In other words, units that you own would be sold to pay for the insurance portion of the ILP.
Whether the NAV of the units is going super high or downright low, the insurance portion still has to be paid. So frankly speaking, it is ”money in, money out kind of thing”.
The worse has yet to come. That insurance portion will be priced according to your age. It is normally called mortality cost and that is the cost of being insured. Thus, year-by-year the mortality cost will increase gradually.
The big worry would be if the mortality cost will be the same or even higher than the NAV of the units. That will slowly bring the overall value of your portfolio. If the sub-fund was performing badly and you do not have sufficient cash value to pay for the mortality cost, you will basically in ‘debt’. Your next premium will be used majorly to pay for the insurance portion and you are not increasing the value of your investment portfolio.
So are you really using your money to good use?
Follow your own risk profile
The example may or may not happen. As investing does involve the act of speculation, it is hard to foresee the outcome of any ILP. But that is one worst-case scenario that might happen.
One way to make sure you are helping yourself when you own an ILP is to regularly monitor the performance of your sub-fund and realize when is a good time to buy or sell it. If you think it is much of a hassle, then you should highly consider other financial instruments.
Before we end, try to imagine a situation where you bought a 2 in 1 hair product. It consists of shampoo and conditioner. You have been using it several times and eventually, you turned bald. Then you wonder, what went wrong? Was the shampoo or conditioner at fault? If you blame both, then it seems like you will not be washing your hair anymore.
Try to apply this example to an ILP. If something went wrong, would you be able to pinpoint the actual reason?
Hope that this article was useful. Do share it with your family and friends. Till next time.
Disclaimer:
I am a financial adviser but I am not your financial adviser. Therefore, what is posted on this website, are my opinions and NOT to be taken as financial advice. Information provided might be relevant at this period of time but may be irrelevant due to alterations to rules, regulations or policies. The information provided is true to the best of my knowledge, but there maybe omissions, errors or mistakes.
