Guide to Investment-Linked Policies (ILP): What you need to know

A polarising life insurance plan that bundles insurance coverage with investment returns – we dissect investment-linked policies to see if such two-in-ones are good additions to your portfolio.

What is an investment-linked plan (ILP)? 

An ILP is a type of life insurance policy offered by insurers that combines protection and investment.

However, unlike whole life insurance, an ILP is often described as a plan that can do it all. You’ll get higher returns than with other types of plans, which means you’ll reach your financial goals faster. You’ll also receive insurance coverage along the way, leaving you free to pursue other interests. Sounds pretty good, right?

Unfortunately, these returns are not guaranteed and will ultimately depend on how the fund performs.  

Furthermore, because of the way they are structured, ILPs are not as straightforward as other insurance plans. Here’s all you need to know about ILPs. How does an ILP work?

With an ILP, the premiums you pay are used to buy life insurance protection and investment units in investment-linked funds. These units are then held on your behalf, until you decide to redeem them — in other words, sell them off in return for cash.

Your returns from the ILP would thus be based on the performance of the fund and are not guaranteed. You can choose sub-funds based on factors such as the fund’s historical performance and risk classification. You can also switch funds or make a lump sum investment top-up when holding on to your ILP.

There are two main types of ILPs:

• Single premium ILP: A single, lump sum premium payment for the ILP. ILPs with single premiums are eligible to be purchased under the CPF Investment Scheme using your CPF Ordinary Account or CPF Special Account — this does not apply to regular premium ILPs.
• Regular premium ILP: A recurring and ongoing payment for the ILP 

An ILP also offers life insurance coverage, providing a lump sum payout upon death or total and permanent disability (TPD). Part of your ILP premiums will go towards paying for this insurance coverage.

With a single premium ILP, while there are initial sales charges and fund management fees, your premium is used to purchase units and there is likely to be no deduction in units for insurance coverage. Regular premium ILPs on the other hand, could require the sale of units to pay for the rising insurance coverage charges.

How do you spot an ILP?

There are many life insurance plans in the market. Here are some factors that can help you spot an ILP:

• Mix of investment and protection: ILPs offer both life coverage as well as investment returns.
• No guaranteed returns or cash value: Keep a lookout to see if there are any guaranteed returns. ILPs don’t offer any guaranteed returns or cash value. Insurance plans such as endowment plans, on the other hand, occasionally offer guaranteed returns that are worth at least the amount of premiums put into the plan.
• High projected returns: As ILPs offer investment returns, you can expect to see high projected returns of around 4 – 8 per cent. Do bear in mind that these returns are projected and non-guaranteed.
• Choice of funds: ILPs purchase units of funds with your premium payments. You might see an option to choose a fund to invest in, or a list of funds available for investment via the ILP. This is one clear characteristic of an ILP.

Here are some examples of ILPs on the market:

• AIA: AIA Pro Achiever, AIA Platinum Pro Secure
• AXA: AXA Flexi Protector, AXA Wealth Accelerate 
• Great Eastern: Great Eastern GREAT Life Advantage, Great Eastern Smart Invest
• Manulife: InvestReady Wealth (II), Manulink Investor
• NTUC Income: GrowthLink, VivaLink
• Prudential: PRULink Supergrowth Account, PRUSelect
• Singlife: Singlife Grow
• Tokio Marine: #goTreasures, #goInvest, #goUltra, #goClassic

Pros and cons of ILPs

As ILPs work differently from other insurance plans, this section will help you to weigh the pros and cons of ILPs carefully before signing up for one.

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Advantages of an ILP

1. Higher potential returns

An ILP could potentially give you higher returns than other types of policies, such as endowment plans. Lest it reminds you of a marketing hook employed by insurance agents, the keyword here is ‘potentially’. You shouldn’t put complete faith in this statement, although there is some degree of truth that ILPs can give you more bang for buck.

This is because the money you pay for your ILP is used to purchase units of a fund. These units can ultimately be sold in the future, which would determine your returns. There is also the possibility of additional bonus units given out, depending on your account value and duration of your ILP premium payment.

Based on the performance of the fund and the time you choose to redeem your units, you could end up receiving a larger payout than from, say, an endowment fund held for the same period. If this is so, you would have achieved a higher return.

However, just because an ILP gives you higher returns compared to other plans doesn’t make it  superior. The true test lies in how much higher your total payout is, against how much you have put in.

It is possible that during an economic downturn, an ILP that showed a higher rate of return on paper could barely break even in real terms.

2. Liquidity with partial withdrawals and top ups

One draw of ILPs would be their liquidity. You can do a partial withdrawal of your funds without the need to surrender or cancel the policy. This could come in handy during times when you face financial difficulties. However, do keep in mind that a partial withdrawal would reduce your account value.

Besides being able to partially withdraw funds, you also have the option to top up your ILP premiums on an ad-hoc basis, adding to your investments when you have more available capital. Even if you choose not to top up your ILP premiums, your regular ILP payments are a form of dollar-cost-averaging, ensuring that you consistently invest in the fund.

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3. Free switching of funds

ILPs give you access to many different funds, sometimes including ones that only accredited investors have access to. You get to choose the fund you invest in, whereby your selection of the fund depends on factors such as the fund’s historical performance and risk classification. This allows you to adjust your portfolio based on your investment objectives, more so than using a robo-advisor that typically has a pre-determined portfolio make up.

However, as ILPs are long-term plans, the fund you choose today might not be the fund that suits your needs a few years down the road.

Some ILPs allow free switching of funds. This allows you to optimise your investment returns by switching your investments to another fund when you deem fit.

4.  Flexibility in insurance coverage

Our insurance coverage could change based on our life stage as we would have different priorities and dependents to care for. An ILP allows you to adjust your insurance coverage as required.

Because of the way an ILP works, you will have greater flexibility to adjust your insurance coverage as you deem fit. Of the units that you bought via your premiums, some of them are sold to pay for the charges of insurance.

Increasing your insurance coverage, then, is a matter of setting aside more units to cover the higher cost of insurance. Of course, this also means that there will be less units invested in the fund, which will impact your final returns.

However, such an arrangement also means that you don’t have to increase your premiums if you want higher insurance coverage. However, for some policies, increasing your coverage could require medical underwriting, with the exception of major life events such as getting married, buying a house or having a child.

5. Premium holidays

If you’re having financial difficulties, you can temporarily stop your premium payments — also known as a premium holiday. This does not terminate your ILP and can come in handy if you are transitioning between jobs, or need to divert your funds to other more pressing financial commitments.

During a premium holiday, your existing units are used to pay for the cost of insurance, as well as any other fees involved in the upkeep of your policy. Hence, you can only opt for a premium holiday if you have enough units to sustain the upkeep.

With a premium holiday, your ILP is kept in force. This is different from other policies, whereby stopping your premiums will result in your policy being terminated – at massive financial cost.

Disadvantages of an ILP

1. No guaranteed returns

Unlike some other insurance plans, ILPs don’t guarantee any returns. This is why it’s considered a higher-risk product. The reason why an ILP can offer flexibility in premium continuity and insurance coverage, and potentially higher returns, is also the same reason behind its largest disadvantage – the returns from your ILP are not guaranteed.

This is not to say that you will definitely lose your capital when you purchase an ILP. Rather, it simply means your insurer is not beholden to provide you with any payouts when you decide to surrender your policy, apart from what your units are worth at the time of surrender.

Depending on your circumstances and your financial goals, this could render ILPs unsuitable for you. If you cannot afford to lose part or all of your capital, you should consider a plan that provides guaranteed returns.

2. Hefty fees and charges

Your investment returns would not only depend on the performance of the fund, but also the fees that you incur. The fees eat into your investment returns.

For example, investment returns of 8 per cent would only be 3 per cent if the costs add up to 5 per cent. For this reason, robo-advisors appeal to many investors with their low management fees of less than 1 per cent.

With an ILP, the investments that you undertake come with high cost. This is due to the sales costs charged by the insurer, fund’s management fee and in some cases, surrender charges amongst other fees.

Depending on the structure of the plan, there are also some ILPs that allocate premiums in the early years to pay for initial expenses such as distribution costs and administrative costs, leaving little funds available to purchase units of the fund.

Do keep a lookout for such ILPs as it could be a high cost to pay, especially when other investment types such as robo-advisors simply charge a single management fee, without additional fees for components such as account opening.

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3. May have to reduce insurance coverage

Due to the way ILPs work, you may need to reduce your insurance coverage. This could be problematic for some.

The cost of insurance rises with age. As we get older, the risk of certain diseases and conditions increases. Correspondingly, it is more expensive to insure a 40-year-old, compared to say a 20-year-old, for the same coverage.

For this reason, you may encounter a situation where your ILP units are no longer sufficient to pay for both your coverage and your investments – even if you are still paying premiums. At this point, you are paying for insurance only, with very little – if any – of your premiums being invested.

Essentially, you’re paying for a glorified (and possibly overpriced) insurance plan with little to no monetary growth. This defeats the purpose of signing up for an ILP in the first place!

In order to free up your units such that your ILP continues to accrue value, you may have to reduce your insurance coverage. This could be a risky move, especially if you’ll be left with insufficient insurance protection or worse, having the policy lapse when you are unable to afford the high cost due to a lack of income.

Having a yearly review with your financial planner is crucial. As your life stages change, so will your risk tolerance, making it necessary to adjust the coverage, supplementing protection gaps through other forms of insurance, and possibly make a fund switch to align with your initial financial goals alongside ever-changing market conditions.

4. Complexity of the plans and their charges

As you might have realised by now, ILPs are a complex type of insurance-cum-investment plan. From the way the plan is structured, to the fees involved, the different types of ILPs available, the options you have when you’re on the plan as well as the funds available; it’s challenging to fully grasp all the details that an ILP entails.

A look at the policy documents will highlight the many different kinds of fees involved. If you’re not comfortable selecting the ILP sub-funds, you could consider other investment options that provide you with a diversified portfolio based on your risk appetite and investment goals.

Things to consider before buying an ILP

If you’re mulling over whether you should really purchase an ILP, here are some factors you can consider:

• Financial situation: How much will the ILP cost and can you afford it in the coming years?
• Purpose of purchasing an ILP: Why are you considering an ILP? Are you looking for life coverage or are you looking to grow your wealth? There are alternatives that could prove more effective for those respective purposes.
• Insurance coverage required: How much coverage are you looking for? Some ILPs can provide more holistic coverage that includes death, TPD and terminal illnesses, while others focus on the investment component and provide a basic lump sum payout upon death. If you are looking for higher coverage, a better option could be to purchase a term life plan instead.
• Availability of other options: With investment products being highly accessible these days, you could take the time to read up on insurance and investments separately to find products that best suit your needs.

For whom are ILPs best for?

An ILP could be a convenient way for you to check all the boxes — insurance coverage and wealth accumulation, coupled with liquidity, access to a huge pool of funds catered to your risk profile and the flexibility to switch funds.

However, due to the high costs and lack of guaranteed returns, you should ideally have a longer investment horizon in order to ride out market volatility in the long term. Furthermore, some ILPs have a minimum investment period or minimum holding amount that would require you to ensure that you can afford the plan.

Also, you should not be dependent on your ILP for your retirement as the returns are projected and there is no guaranteed cash value. The cost of the insurance coverage would also increase with age, making ILPs more suitable for those with time on their side.

Differences between ILPs and other life insurance plans

There are two types of life insurance plans that you can consider to provide you with life coverage instead of an ILP: whole life vs term life insurance. Both of these life insurance types offer different value propositions.

Whole life: Whole life insurance plans provide the life assured with insurance coverage for life. This could be up till 99 years old, or until death, giving your dependents lifelong protection.

There are similarities between a whole life insurance plan and an ILP. Participating whole life plans can offer bonuses that are dependent on the performance of the participating fund. Unlike an ILP whose surrender value is purely based on the performance of the funds, whole life plans can offer guaranteed cash value even if you choose to surrender the plan in the future.

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However, this cash value can only be withdrawn when you surrender the policy, which means that you will be losing your life coverage. ILPs on the other hand, have the option for a partial withdrawal while still allowing you to retain your insurance coverage.

While there are many reasons why people choose whole life plans, they are considerably more expensive compared to term life plans. This is why some people opt to buy term insurance and invest the rest.

Term insurance: High coverage, low cost. Term insurance plans provide coverage for a specified period. They are also purely for protection and do not offer any cash value, making them a fairly straightforward type of life insurance product.

Choosing between the two types would ultimately depend on your personal preference and coverage requirements. Whole life and term life plans can also be used hand in hand to help you maximise your coverage and accumulate wealth.

Investment alternatives to ILPs

We’ve covered life insurance in the section above. While some people might consider an ILP for its investment returns, there are other alternatives available today that come at low cost.

If you’re looking for ways to grow your money, here are some options for you to consider.

Robo-advisors: Robo-advisors have become a go-to option for young investors, offering investment portfolios that can be curated based on factors such as your risk tolerance, investment horizon and investment goals.

These portfolios are also offered at low cost, with low or no minimum investment amount requirements, lowering the barrier of entry for new investors. Funds can be deposited and withdrawn with no additional cost.

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You can also use not just your cash, but also your CPF money or Supplementary Retirement Scheme (SRS) funds to invest, depending on the robo-advisor.

Exchange Traded Funds (ETFs): A type of security that trades on the financial markets, ETFs typically track an index and can offer diversification.

Real Estate Investment Trusts (REITs): REITs are a popular investment vehicle amongst Singaporean investors, offering high dividend yields which make them a great asset to bring in passive income.

Unit trusts: Unit trusts, also known as mutual funds, can easily be purchased on financial platforms. You can also invest in unit trusts through robo-advisors.

Stocks: You can select individual stocks to make up your investment portfolio. To get started, open your Central Depository (CDP) account and brokerage account.

If you’re looking for products with lower risk but also modest returns, you can also consider products such as endowment plans, fixed deposits, Singapore Savings Bonds (SSBs) and insurance savings plans.

In conclusion

Ideally, your financial portfolio should be made up of different financial instruments, which come together to serve all your needs. It is dangerous to have only one or two types of plans, and expect to be fully covered; this holds true for any insurance or investment plans, and not just ILPs.

All in all, ILPs offer distinct advantages, but also come with some pretty gnarly risks. To help you plan how best to employ an ILP (or determine if such a plan is even suitable for you), seek the advice of a qualified financial adviser or wealth manager.

This article was first published in SingSaver.com.sg.