Investment-linked insurance: No panacea for returns or protection

MANY Singaporeans gravitate towards products with some guarantee, such as participating and non-par insurance plans. But life insurance sales for 2024 threw up a surprise.

Investment-linked plans (ILPs) streaked far ahead of par plans, with a surge of 41 per cent to S$2.25 billion in 2024, indicated Life Insurance Association (LIA) data. Meanwhile, par products dipped by 2.7 per cent.

ILPs are investment funds in an insurance wrapper. In contrast to par policies where the insurer invests on behalf of policyholders, in ILPs, policyholders pick funds and assume the investment risk.

The death benefit can be minimal – just 101 to 105 per cent of the premiums. A death benefit is needed to qualify it as an insurance product.

Sales of ILPs typically rise along with market sentiment. Last year, equity markets delivered strong double-digit returns.

LIA said: “More consumers are leveraging ILPs for wealth accumulation, especially amid economic uncertainty and rising interest rates, as these policies provide life insurance protection while offering higher potential returns.

“In particular, regular premium ILPs, which help mitigate market timing and volatility through dollar-cost averaging, are seeing a surge in uptake.”

Insufficient protection

As a product class, ILPs raise some challenges for insurers, especially with the predominant design today, which is a back-end loaded structure for costs. I’ll tackle that in a moment.

ILPs’ investment returns are not certain. The death benefit is funded mainly by premiums and may not be guaranteed.

Are they a good idea for your financial plan?

MoneyOwl chief executive Chuin Ting Weber cautioned that today’s plans, with a token coverage of 101 to 105 per cent of premiums, do not provide enough death cover to be meaningful.

“The Monetary Authority of Singapore’s Basic Financial Planning Guide suggests nine times annual income for life coverage as a rule of thumb. From a financial planning standpoint, this sum assured needs to be available immediately and in full, no matter when (death) takes place.”

“This is the essence of insurance – that you get a big enough payout for an event whose timing you cannot control. The fit-for-purpose instrument is a term life plan.”

She added: “Saving and investing through an ILP does not give you sufficient protection, as it takes far too long to accumulate sufficient value equivalent to the coverage needed, even at a high projected return.

“Given that the primary purpose of insurance is protection, we recommend that consumers have at least the basic core coverage first.”

Cost concerns

For many years, I have avoided writing about ILPs for a few reasons.

One, their structure is inherently costly. In addition to distribution costs, which dial down to zero after some years, most plans have high recurring fees.

For this piece, the highest charge I’ve seen, based on product summaries on compareFirst, may exceed 4 per cent a year. These costs – variously called admin, policy, or supplementary fees – are charged monthly via cancellation of units. They are separate from the underlying investment funds’ annual management fees.

Two, even though a policyholder can make partial withdrawals from or surrender a policy anytime, there will be high penalties if this is done in the early years. It is possible, however, to take a break from premium payments after some years, depending on plan design.

Three, there are lower-cost options through robos and even some banks, to enable investors to ride out market volatility by dollar-cost averaging through a regular savings plan (RSP). In these options, you are free to pause your RSP or redeem units should you need to tide over a cash flow need.

Endowus, for instance, has an all-in cost of 0.25 to 0.6 per cent a year. The funds on its shelves also have lower annual management fees because it rebates trail fees back to investors. Trail fees are the portion of the fund management fee paid to distributors.

DBS has also shaved the fees of its digiPortfolio series by up to half. For the Retirement digiPortfolio, investors pay 0.75 per cent in annual management fees in the accumulation phase, and 0.25 per cent once they reach retirement age.

Innovations

Over the past few years, some innovations have emerged in ILPs.

• Front end vs back-end loaded policies: In the past, most ILPs were front-end loaded. This meant that expenses such as distribution costs were taken from premiums up front in the early years.

In a back-end loaded policy, 100 per cent of premiums buy units from the start. Insurers will need to fund the upfront costs themselves, such as distribution and any “welcome” bonus units.

These costs are eventually recovered via recurring charges and other charges such as surrender penalties. Whether front-or back-end loaded, “the overall effect of the charges will be similar”, said LIA in its guide to such plans.

• Locking in higher death benefits: The protection value is partly a function of the investment value, which can rise and fall. Some policies have a feature to lock in the highest investment value, to give a higher death benefit.

Prudential claims to be the first to offer this in 2021 in its PruVantage Assure plan, to “lock in coverage at the peak policy value” for death and accidental disability.

TM Asia has a similar feature, which it describes as a “high watermark” for protection. The death benefit is paid net of any indebtedness or withdrawals. If investment value drops below the locked-in death benefit, a mortality charge typically applies.

• Depending on plan, bonus generous units: FWD, in its Invest First Max ILP, can pay up to 186 per cent in “booster units” in the first two years “to give the policy a head start to accumulate investment returns over time as ILP fund returns are compounded at a higher initial policy value”.

They may pay an initial or welcome bonus, loyalty and special bonus units once you have paid premiums for some years.

• No bid-offer spread for underlying funds: The purchase and cancellation of units to defray costs are based on a single unit price.

Higher fees, lower net returns

How much of the increased purchase of ILPs is due to people’s genuine preference or need, versus distributors and insurers looking to gain a lucrative engine for fees?

They provide insurers with multiple sources of revenue, including the admin charges, trail fees and exit charges for surrender and withdrawals. The admin and trail fees are generally not shared with distributors. But some insurers such as Manulife do share a portion of the admin fee.

For investors, it is important to keep two principles in mind. One, almost nothing is guaranteed. Even the death benefit may not be guaranteed.

Two, volatility and returns are not within your control. The single factor you can control is fees, which are a major friction in returns. You can simply walk away from high-cost structures. The maths is simple: Higher fees spell lower net returns.

Eddy Cheong, chief executive of Havend insurance advisory, said: “We find that many clients don’t seem to understand beyond the coverage and premium they pay. They are unsure of the charges and sometimes the funds they’ve invested in. Many assume that their investment will perform, and some had a reality shock when their cash values are below projection.”

He added that ILPs’ scheme of initial and loyalty bonus units do help to mitigate the costs, “but with conditions like high early surrender charges”.

“It seems to serve more as a marketing gimmick to make the policy looks attractive, especially to the layman. The overall charges are still relatively high compared to pure investment alternatives.”