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Understanding investment-linked insurance policies

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29 Oct 2018 | 5 min. read

Investment-linked insurance policies (ILPs) have both a life insurance and an investment component. Find out how ILPs work and what you should know if you are considering whether to buy one.

Key takeaways

  • ILPs combine life insurance coverage and investment.
  • Investment returns are based on the sub-fund’s performance, so you need to select one that meets your investment objectives and risk profile.
  • You bear the full investment risk, there are no guaranteed returns.
  • Insurance charges are paid for by the investment portion of the ILP. Such charges rise with age and there is a risk that your units may not be enough to pay for them.

What it is

Investment-linked insurance policies (ILPs) are policies that have life insurance coverage and investment components.

Your premiums are used to pay for units in one or more sub-funds of your choice. Some of the units purchased 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 if included, total and permanent disability (TPD). Depending on the policy, the death or TPD benefit may comprise the higher of the sum assured or the value of the units in the sub-fund at that point in time or some combination of the two.

The value of these units depends on their price, which in turn depends on the sub-fund’s performance. This is why ILPs usually do not have any guaranteed cash values.

Why invest in ILPs?

Some consumers value ILPs because of their flexibility.

  • You can change your investments by switching sub-funds when your financial needs change. In addition, you may also top up your investments and make partial withdrawals.
  • Most regular premium ILPs give you the flexibility to vary the insurance coverage as your needs change. For example, you can reduce the coverage (subject to a minimum sum assured) or even increase it (subject to underwriting).

But if you are only concerned about getting insurance coverage, an ILP may not be the most suitable product for you.

Types of ILPs

ILPs can be classified into two categories:

  • Single-premium ILPs – You pay a lump sum premium to buy units in a sub-fund. Most single premium ILPs provide lower insurance protection than regular premium ILPs.
  • Regular premium ILPs You pay premiums on an on-going basis. Regular premium ILPs may allow you to vary the level of insurance coverage you need.

Tip

Some ILPs may be categorised as Specified Investment Products (SIPs). Do check with your financial institution whether the product you are considering is an SIP.

How the investment portion works

The investment strategy of an ILP is determined by your selection of the sub-funds. This is unlike whole life or endowment policies where the insurer determines the investment strategy.

Since an insurer will normally provide you with a range of sub-funds to choose from, it is important that you understand the sub-fund’s investment strategy and approach, as well as the potential risks.

Tip

If you don't need the insurance coverage, you may consider unit trusts and exchange traded funds (ETFs) instead.

What to consider in choosing a sub-fund

Choose one of more sub-funds that suit your investment objectives and time horizon.

The sub-fund’s historical performance should not be your only consideration. Make sure that you are comfortable with the sub-fund’s risks and that these are consistent with your risk profile:

  • Some sub-funds offer greater potential for higher returns but come with an increased risk of financial losses. On the other hand, other sub-funds (such as cash sub-funds), may be expected to yield more modest returns in exchange for relatively lower risks.
  • For all ILP sub-funds under the CPF Investment Scheme, the CPF Board will assign a risk classification. Do note that these risk classifications only serve as a very broad guide on whether the sub-fund is suitable for you.

Switching sub-funds

ILPs allow you to move your money from one sub-fund to another. This is known as fund switching.

It may be helpful for you to consider this if your financial circumstances or risk appetite have changed and you no longer find your current sub-fund suitable.

Most insurers offer a limited number of free switches and charge a nominal fee per switch thereafter. Before switching from one sub-fund to another, check whether you are entitled to free switches and if not, how much you would need to pay for the switch.

See also: Investment-linked versus participating life insurance policies

How the insurance portion works

While you are paying the same monthly premium throughout the life of the policy, the cost of insurance typically increases year on year (as you get older the risk of death, disability and illness increases). This is even if you maintain the same coverage (i.e. sum assured).

This means that more units may be sold to pay for the insurance charges, leaving fewer units to accumulate cash value under your policy.

If you have a combination of high insurance coverage and a poorly performing sub-fund, the value of your units may not be enough to pay the insurance charges. You will have to top up your premium or reduce the coverage.

Tip

If protection is your main goal, other products such as term insurance, may offer higher coverage at a lower cost.

See also: ILPs: Guide to fees and pricing

What are the risks?

Common risks associated with ILPs include the following:

Investment risk

  • The returns are not guaranteed. The value of an ILP depends on how the sub-funds perform.
  • Do not rely on the past returns of a sub-fund as an indication of its future performance.

Insurance coverage charges

  • Insurance charges rise with age. Your units may not be enough to pay the charges.
  • For regular premium ILPs, insurers may also increase the cost of insurance coverage, if there has been a sustained rise in claims. If so, any increase would be applied to an entire class of policies and not just to an individual policy.

What's the most you can lose?

ILPs usually do not have any guaranteed cash values. Hence, you can potentially lose the entire value of your investment.

Before you invest: Things to note

Consider if an ILP is suitable for you:

  • ILPs are better suited for those with a longer investment horizon to ride out market fluctuations and defray initial costs which can significantly limit short-term potential returns.
  • The insurance coverage between ILPs differ. Some are more investment-oriented with very little insurance coverage, whilst others will allow you to set the level of coverage that you require. Do note that the more you are covered for, the more units will be needed to pay for the coverage and that leaves less units to be invested.
  • Do consider whether you can keep up with the premiums if you no longer earn an income.
  • Do compare investing through an ILP against investing in other investment products. In some cases, the sub-fund that you are interested in may also be offered as a unit trust (i.e. without insurance coverage).

Tip

If insurance protection is your main goal, then you may wish to consider other insurance options.

After you invest: Review your statements

Read your ILP statements, which your insurer will send to you at least once a year (or more frequently). This statement shows the value of units in the policy, transactions for the period and charges paid through the sale of units.

Do review this statement to check if the ILP and sub-funds selected continue to suit your needs. Seek advice if your circumstances and what you need have changed.

Using CPF for ILPs

You can use your CPF savings to buy an ILP if the ILP is included under the CPF Investment Scheme (CPFIS). The CPF Board assigns a risk classification which serves as a broad guide to all ILP sub-funds under CPFIS.

Last updated on 02 Nov 2018