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Investing via regular premium insurance plans? Watch the costs
REGULAR premium investment-linked insurance plans (ILP) are a staple among life insurance companies' offerings. The attraction of such plans typically lies in the bundling of insurance and investment, even if the protection value may be modest at best.
ILPs are policies where policyholders decide on their own asset allocation and funds, in contrast to participating policies where the insurer invests premiums collectively.
But if your objective is to commit to a long-term investment, you should scrutinise and compare ILPs' charges, which are substantial and are separate from the underlying investment fund charges. Costs are a significant drag on returns. You may be able to do better by buying term life protection separately, and investing regularly in a portfolio of unit trusts. Some financial advisers are able to build portfolios using wholesale share classes of funds, where you save significantly on annual management fees.
In some cases the insurer's charges could add over 2 per cent to the total cost, which are typically not reflected in the investment fund's total expense ratio. A worst case scenario could see the effective total expense ratio - comprising insurer and fund charges - balloon to over 3 per cent. This is a significant hurdle in an environment where expectations of long-term returns from traditional capital markets are muted at best.
Based on the Life Insurance Association's latest quarterly data, new business inflows into single premium linked policies rose 43 per cent to S$197 million in the six months to end-June, compared to S$137.5 million previously. Non-linked policies which include participating policies are favoured among Singaporeans, generating S$480 million in sales in the first six months.
This piece focuses on ILPs for investment - in regular premium (RP) or recurring single premium (RSP) mode - where the protection value may be as little as 102 per cent of a single premium in a RSP plan or five times the annual premium in a regular premium plan. The sum insured is typically for death and total and permanent disability. Some insurers may throw in a terminal illness benefit. ILP benefit illustrations (BIs) reflect two projected rates of return at 4 and 8 per cent. These are only for illustration and do not reflect any fund's performance.
Here are some of the major cost items you should be aware of. Costs are typically charged via cancellation of fund units at the bid price. Policyholders typically purchase units at offer price, so the insurer earns the bid/offer spread even in RP mode.
- Mortality charge. This is the cost of insurance. This cost is not guaranteed and is charged based on the policyholder's age, gender and smoking status, among other factors. In ILPs where the death benefit is minimal, the insurance cost may be based on the sum-at-risk. This means there is no mortality charge if the policy value exceeds the total premiums paid plus any top-ups, but less any withdrawals. Some insurers, however, continue to levy an insurance cost regardless of policy value. Interestingly, there can be major differences among insurers in the mortality charge, which is itemised in a sheet in the BI.
There is also a scenario where the value of your units is insufficient to pay for the insurance cover. In this case you may be asked to top up your premium, or the policy may lapse.
- Fund sales charge. This varies among insurers and is quoted at up to 5 per cent based on the BIs perused by The Business Times. The rub is that for a long-term contract, with a myriad of ancillary charges, insurers can well afford to reduce the bid/offer spread to a nominal rate, if there must be one at all. AIA in fact says there is no bid/offer spread for its regular premium policies. A premium charge of 5 per cent, however, applies to top-ups. Manulife also does not have a bid/offer spread on its underlying funds. Great Eastern's bid/offer spread is 5 per cent for its SmartInvest (RSP) plan, and 3 per cent for the Prestige Portfolio plan; Income's is 3.5 per cent for the Vivolink plan, but it also gives an extra 0.5 per cent bonus unit for all top-ups which reduces the effective spread to 3 per cent.
- Table of deductions. Regular pre-mium ILPs' benefit illustrations have a sheet reflecting the table of deductions, which shows estimates of the value of all deductions for the cost of insurance, distribution costs, expenses, surrender charges and expected tax payments. What you should scrutinise, if available, is the "reduction in yield'' explanation. This gives an indication of the policy's expense ratio, but does not include the underlying fund's expense ratio.
Not all insurers disclose the reduction in yield; this disclosure is not required. AIA has the clearest disclosure in this respect, as it states the reduction in yield for both the 4 and 8 per cent scenarios. For its illustration for a 30-year old male (AIA Pro Achiever; annual premium S$2,400), total deductions reduce the yield from 4 to 2.7 per cent for the 4 per cent projected rate of return in the 35th year of the policy, or age 65. For the 8 per cent illustration, the yield is reduced to 6.5 per cent. These numbers suggest a long- term policy expense ratio of 1.3 and 1.5 per cent, respectively. If your BI does not have this, please press your insurer for the calculation.
- Supplementary charge/Wrap charge. These may well be the largest cost items. AIA's BI for the AIA Pro Achiever lists a "supplementary charge'' of 2.5 per cent per annum, which applies for 12 years. The payment period may be extended if the policyholder misses any premium payment. Manulife also levies a supplementary charge for its InvestReady - Wealth plans of 1.8 per cent. This is payable for 10 years. Its BI says the charge may be raised to 3.6 per cent per annum with 30 days written notice. GE's Prestige Portfolio lists a wrap fee of 1.5 per cent a year of the total investment value, paid for via cancellation of units. Prestige Portfolio is positioned for more affluent clients, and allows some customisation of clients' investment needs.
- Administration charge. This is typically expressed as a finite dollar value. Prudential, for example, charges S$5 a month. Income calls this a policy fee to cover the cost of policy administration, at S$5 a month. For its Smart Invest (RSP) plan, GE does not charge a policy fee in the first three years. From the fourth year, a S$2 monthly policy fee is charged. This may be raised up to S$5 a month with one month notice. Manulife's fee is 0.7 per cent, with the right to raise it to 1.4 per cent with 30 days' notice.
- Surrender charge/Allocation rates. The practice of surrender charges and premium allocation rates varies among insurers. AIA, for instance, allocates 100 per cent of premiums for regular premium plans into units from the first to the 12th year. From the 13th year, the allocation rate rises to 105 per cent. But the surrender charge is 100 per cent in the first two years, and declines to zero from the 13th year.
Income's premium allocation rate and surrender value vary with the plan. For Vivolink, which has generally lower protection value, the premium allocation starts at 55 per cent in the first year, and goes up to 100 per cent from the third year (37th month). The surrender charge starts at 25 per cent for a term of less than 13 months, and dials down to 5 per cent between the 49th and 60th month.