Investment-linked insurance plans: That welcome bonus could cost more than you expect

RECENTLY, The Straits Times reported that while sales of investment-linked insurance policies (ILPs) grew by 72 per cent from 2022 to 2024, complaints against them were also at all-time high in 2024 – at 211 complaints against 53 in 2023.

Eunice Chua, chief executive of Financial Industry Disputes Resolution Centre (Fidrec) said it became clear during the mediation sessions that most consumers did not really understand what an ILP was. Many complaints pertained to market misconduct, which included practices such as mis-selling, misrepresentation, inadequate disclosure about the products or giving inappropriate financial advice.

Why are ILPs so difficult to understand?

In recent years, insurers launched wealth accumulation-based ILPs, known in the industry as “101 ILPs” because the insurance coverage is 101 per cent of the value of the investment or total premiums paid, whichever is higher.

These policies seem attractive because typically, 100 per cent of the premium is invested and a “welcome bonus” is given. After a certain period, policyholders receive annual loyalty bonuses. But this is where it gets complicated.

While the ILPs offered take different forms, the way fees charged for them are broadly structured in two ways.

The first is a single account to hold all the units of the underlying funds or unit trusts you purchased with your premiums, including the bonus units given. Insurance companies charge policy fees on the value of the units in this account. The fees could be higher in the first “x years” where “x years” refer to the period you are not allowed to terminate your policy or make partial withdrawals beyond an allowed amount. This is equivalent to a lock-in period; lower fees apply after the lock-in period.

The second is the dual-account structure, under which one account holds the units purchased and the bonus units given during first “x years”. A second account holds units bought and/or given after “x years”. Insurers typically charge a higher fee on the first account and a lower one on the second.

Using the single-account structure as an example, the accompanying graphic shows the cost of a 101 ILP with a 10-year lock-in, assuming that there is no growth or losses in your investment after fees.

By the end of the 10th year, you would have paid S$3,002.50, about 150 per cent of your first-year premium in fees! These means all the welcome bonuses given to you are gone.

Of course, insurers operate differing bonus schemes, but what you need to know is that there is no free lunch. While the welcome bonus of 75 per cent may sound exciting, the fees eat into that, and over time, they eat all of it. This is the same with loyalty bonuses given after the lock-in period. The ongoing fees also eat into those bonuses.

Then of course, there is another layer of fees – the annual management fee of the underlying unit trusts that you purchase. Because most ILPs invest into actively-managed funds, the fees are high relative to low-cost funds such as exchange-traded funds (ETFs). Even among the few ILPs that use index funds, the total expense ratio is still relatively higher than if you were to buy an index fund or ETF directly, without using an ILP wrapper.

So how much are you actually paying?

In 2023, my firm conducted an in-depth research on 101 ILPs. To determine the cost, we used each insurer’s benefit illustration to calculate the projected net annualised returns of the ILPs. The net annualised returns are net of underlying funds’ total expense ratio, welcome and loyalty bonuses, as well as other ILP fees.

By calculating the difference between these sets of numbers and their projected gross return, the team was able to determine the total annualised cost of these ILPs across insurers at the end of different years.

Such information makes it clear how complicated 101 ILPs can be, why many consumers do not understand the ILPs they have bought, and why complaints have risen.

My firm Providend doesn’t use ILPs for these reasons:

• Most ILPs invest in actively managed funds, and there is enough evidence to show that most active funds do not outperform the index. Those which do so cannot keep it up consistently.
• As you can see in the accompanying graphic, the cost structure of ILP is not easily understandable and, in our opinion, too high.
• There are limited choices of funds within the insurers’ ILP universe.
• The lock-in period is a big problem in investment management. If we do not like the performance of the funds, we cannot switch over to another fund that is not in the insurers’ menu without incurring a huge loss.
• We typically like to use instruments that can all be transacted on a single investment platform. ILPs sit with the insurers and not on such platforms. This makes investment management operationally inefficient when it comes to rebalancing and fund switches.

Personally, I cannot think of a convincing reason why ILPs should be part of an investor’s portfolio. And after two decades of writing and talking about ILPs, I am disappointed that sales of ILPs are still on the rise.

This is probably because the promise of high welcome and loyalty bonuses has distracted investors from understanding their real underlying cost and disadvantages.

With so many other better investment options in financial markets, why subject yourself to high fees, limited fund options and a lock-in structure in an ILP? It makes no sense at all.

The writer is chief executive, Providend, Southeast Asia’s first fee-only, comprehensive wealth advisory firm.