Investment-Linked Insurance: Navigating The Pros And Cons

Investment-linked insurance policies (ILPs) are a type of life insurance that combines coverage with investment returns. ILPs are often described as a plan that can do it all, offering higher returns than other types of plans and insurance coverage, leaving you free to pursue other interests. However, these returns are not guaranteed and depend on the performance of the fund. ILPs are also more complex than other insurance plans. So, should you buy investment-linked insurance?

What is an investment-linked plan (ILP)?

An Investment-Linked Plan (ILP) is a type of life insurance policy that combines protection and investment. In other words, it offers the twin benefits of life insurance protection and investment.

When you purchase an ILP, your premiums are used to buy life insurance protection and investment units in investment-linked funds. These funds are managed by experienced financial professionals and can focus on different sectors, such as stocks in the US or EU. The funds are then held on your behalf until you decide to redeem them by selling them off in return for cash.

There are two main types of ILPs: single-premium ILPs and regular-premium ILPs. With a single-premium ILP, you make a single, lump-sum premium payment for the policy. This type of ILP may provide lower insurance protection than regular-premium ILPs. Regular-premium ILPs, on the other hand, involve recurring and ongoing payments, often on a monthly or annual basis. They allow you to invest consistently and may give you the option to vary the level of insurance coverage you need.

The main advantage of an ILP is that it offers the potential for higher returns compared to other types of policies. However, these returns are not guaranteed and depend on the performance of the fund. Additionally, ILPs offer flexibility, allowing you to adjust your insurance coverage and investments. You may also be able to take advantage of features like premium holidays and free fund switches.

However, it's important to consider the disadvantages of ILPs as well. There are no guaranteed returns, and you may have to pay hefty fees and charges that erode your investment returns. As you age, the insurance charges of the policy increase, and you may need to reduce your insurance coverage to continue affording the charges. The complexity of ILPs and their charges can also make them challenging to understand fully.

Pros and cons of ILPs

Pros of Investment-Linked Plans (ILPs)

• ILPs can help people who are not disciplined with their finances by taking a sum of their money each month to cover both insurance and investment.
• Some ILPs offer access to exclusive funds that are hard to find elsewhere.
• ILPs offer flexibility with the option to make top-ups, adjust premiums, and switch packaged funds.
• ILPs offer liquid funds with zero lock-ins, meaning that partial withdrawals are allowed at any time throughout the policy’s lifetime.
• ILPs provide insurance protection in the event of death, and in some cases, total and permanent disability (TPD).

Cons of Investment-Linked Plans (ILPs)

• ILPs have many layers of unexpected and unseen costs, which can sometimes be more expensive than separate life insurance policies and investments combined.
• ILPs carry investment risk and do not always provide guaranteed returns, making them a relatively higher-risk option.
• ILPs are extremely complicated products, and the returns depend on the performance of the sub-funds.
• Insurance charges rise with age, and there is a risk that your units may not be enough to pay for them.
• ILPs are not suitable for those who are only looking for insurance coverage.

How do ILPs compare to other insurance plans?

Investment-Linked Policies (ILPs) are often compared to whole-life insurance policies, as they share some similar features. Both plans offer protection against specified conditions, require premium payments, and help you accumulate a cash value. However, there are some key differences to note when comparing ILPs to other insurance plans.

Firstly, ILPs are sold by insurance companies, and it is possible to add "riders" that boost insurance coverage. Riders extend the scope to include events that were not previously included in the policy. In contrast, whole-life policies typically do not offer this level of flexibility.

Secondly, ILPs are positioned as products that provide the highest potential returns out of all insurance plans. They are marketed as a good way to grow your money, with the potential for high returns. On the other hand, whole-life policies have lower projected returns, typically ranging from 3.25% to 4.75%.

Thirdly, ILPs are considered investment plans that offer coverage similar to an insurance plan, whereas whole-life policies are primarily insurance plans that accumulate cash value over time. In an ILP, your premiums are used to buy fund investment units, which are then sold to pay for insurance and other charges. In contrast, with a whole-life policy, your premiums are used to pay the costs of insurance, meaning you are paying the insurer to bear the financial costs of a serious medical accident or condition.

Another difference to note is that ILPs do not provide guaranteed cash values, as they are dependent on the performance of the funds your premiums have been invested in. On the other hand, a participating whole-life policy will have a guaranteed cash component that increases over time. A non-participating whole-life policy may not provide any guaranteed cash value or only a very small amount.

When comparing ILPs to other insurance plans, it is important to consider your financial goals and risk tolerance. ILPs can be a good option if you are looking for higher potential returns and the flexibility to switch between sub-funds. However, it is important to note that ILPs come with higher fees and insurance costs, and the returns may be inconsistent or lower than expected. Therefore, it is crucial to carefully consider your needs and understand the pros and cons of any insurance policy before making a decision.

What are the alternatives to ILPs?

There are several alternatives to ILPs, each with their own advantages and disadvantages. Here are some options to consider:

Term Life Insurance

Term life insurance provides coverage for a specified period and is purely for protection, without any investment component. It is often more affordable than ILPs and can offer higher coverage for a lower cost. However, it does not provide any cash value or returns, making it a straightforward insurance product.

Whole Life Insurance

Whole life insurance offers lifelong coverage, typically until the age of 99 or death. It can provide guaranteed cash value upon surrender of the policy, even if the fund performance is poor. However, this cash value can only be withdrawn upon surrendering the policy, resulting in a loss of life coverage. Whole life insurance is also generally more expensive than term life insurance.

Robo-Advisors

Robo-advisors have gained popularity among young investors due to their low costs and curated investment portfolios based on risk tolerance, investment goals, and horizon. They offer low or no minimum investment amount requirements and allow for flexible deposits and withdrawals without additional costs. This makes them more accessible to new investors.

Exchange-Traded Funds (ETFs)

ETFs are traded on financial markets and typically track an index, offering diversification to investors. They are a good option for those seeking a passive investment approach.

Real Estate Investment Trusts (REITs)

REITs are a common investment vehicle in Singapore, offering high dividend yields and a steady source of passive income.

Unit Trusts/Mutual Funds

Unit trusts, also known as mutual funds, can be easily purchased on financial platforms or through robo-advisors. They provide investors with a diversified portfolio and are similar to the sub-funds offered within ILPs.

Stocks

For those who want more control over their investments, selecting individual stocks to build a portfolio is an option. This requires opening a Central Depository (CDP) account and brokerage account.

Other Low-Risk Options

For those seeking lower-risk alternatives, products such as endowment plans, fixed deposits, Singapore Savings Bonds (SSBs), and insurance savings plans offer modest returns with less risk of capital loss.

When is life insurance not worth it?

Life insurance is not worth it if you do not have any dependents or debt. If you are single, financially independent, and have no large debts, you can probably skip a life insurance policy. However, if you have loved ones who depend on you financially, or you have debts that would be burdensome for your family if you died, then life insurance is likely worth it.

The cost of life insurance, especially permanent life insurance, may be greater than the amount of money needed at the time of your death, especially if you do not have dependents. In this case, you may be paying premiums unnecessarily and could potentially invest that money more profitably elsewhere.

Permanent life insurance could also have tax implications for yourself or your beneficiaries if you surrender a policy or you pass away with an outstanding loan against the policy. Therefore, it is important to consider the financial implications and potential risks associated with permanent life insurance policies.

Additionally, if you are looking for a form of investment to build your portfolio, life insurance may not be the best option. There are plenty of other investment opportunities available, such as robo-advisors, unit trusts, and exchange-traded funds (ETFs).

Finally, if you are only concerned about getting insurance coverage, an investment-linked policy (ILP) may not be the most suitable product for you. ILPs combine life insurance coverage and investment, and the insurance charges are paid for by the investment portion of the ILP, which can rise with age. There are no guaranteed returns, and you bear the full investment risk.

Frequently asked questions