Investment Linked Insurance or Unit Trust ??

A close friend of mine asked me to write about the option between unit trust and investment linked insurance. It seems to be a common question to many. My personal view on this would be whatever choices we made, be it unit trust investment, or insurance product, we need to have a good understanding of the underlying nature of the product, so that we can select products that best meet our needs.

First of all, before we get excited over the variety of products offered in the market, we need to always go back to the basics. As a basic guideline, we need to first remember why are we buying insurance in the first place? Primary objective of insurance is for protection. If you have dependents, it is vital that you are protected with adequate insurance policies like life/critical illness/medical insurance, before you think of other investment option like Unit Trust. Investments take longer to accumulate to the level that may be required by your dependents, whereas insurance benefits can immediately meet those needs if required.

I suppose that’s what has made investment linked insurance products grow very rapidly- trying to kill two birds with one stone, ie. having insurance protection and at the same time not missing an opportunity to participate in investment. However, it is vital to be aware that insurance and investment are two different things. People buying such investment linked products should have a clear understanding how the product works.

There are benefits of buying an investment linked insurance such as a much lower premium layout and a chance to invest with the help of professional investment experts whilst enjoy life insurance protection etc. Here, other than the commonly shared benefits, I will try to list out a few main points which I think are important to be aware of:-

1. What is an investment linked product (ILP)

ILP is a life insurance plan that combines investment and protection. The premiums you pay provide you not only with life insurance cover but part of the premium will also be invested in specific investment funds of your choice.

2. How does it work?

A portion of premium payment is used to purchase units in the investment linked funds managed by the insurance company. The protection coverage is provided by paying the insurance charges, fees and other related expenses via the deduction of the premium or sale of units from the investment funds.

3. What are the risk of purchasing ILPs?

ILPs offer the potential for higher returns compared to traditional life insurance if you opt to invest in equity related funds. However, unfortunately, higher return always come with higher risks.

Just like unit trust investments, the investment returns are not guaranteed, the price of the units can rise or fall. Needless to say, the investment risk will be 100% borne by the policy-holder. It has no guaranteed minimum surrender value like endowment or term life insurance.  If a fund does not perform well, the cash and maturity values will be adversely affected.

One of the benefit of ILP is for the same protection given, the premium required tends to be much lower compared to a traditional term life policy and is meant to remain the same every year . However whilst premium is expected to remain the same, the insurance charges is subject to change! The insurance charges start off low when you are young and increase as you get older.

For most regular premium ILPs, insurance coverage charges are paid through the sale of units. For eg, if the insurance charges is RM 100, and the bid price of the fund is RM0.95. The number of units sold to pay for the insurance charges would be:-

RM 100/ RM 0.95 = 105 units

As you get older, your insurance charges get higher but the premium that you paid is expected to remain the same based on certain assumptions about the performance of the fund. However, if the fund performs poorly, the value of the units may not be adequate to meet the insurance coverage charges. For eg, now your insurance charge has increased to RM 500, and the fund price has dropped to RM 0.50, total units that you have to sell to pay for the premium would be 1000 units. What if, unfortunately, your total available fund units were less than 1000 units?

So, what would happen then?. You have two choices – 1. reduce your protection coverage, just when you needed it the most when age is catching up; or 2. to top up your premium to cover high insurance coverage charges.

Just a personal experience to share, my husband bought an investment linked insurance more than 10 years ago, and was under the impression from his insurance agent that he can stop paying his premium after 12 years of his policy. Unfortunately, to his surprise, after years of paying the premiums, he was asked to top up the premium instead due to poor performance of the fund! Such “surprises” can completely disturb your financial plans.

4. How much of the premium is used to purchase units?

Unlike unit trust investments, the full amount paid may not always be allocated to purchase units. Before buying the ILP, it is important to find out what percentage of your premium would be used to purchase units. Usually, from the beginning years a bigger portion of the premium paid is used to pay for the insurer’s expenses such as agents fees and administration costs. Hence smaller portion would be used to purchase investment units. These expenses decrease over time, the premium allocation increases to purchase units increases until it reaches 100% in later years. From what I gather, for most insurance companies, the 100% premium allocation takes place after the 6th to 7th years.

5. Will the level of protection affect cash values of the policy?

Yes, it would. It is needful to understand that for the premium you wish to pay, there will be a trade off between the amount of insurance coverage provided and the amount available for investment. The higher the level of coverage selected, the more units will be absorbed to pay for the insurance charges and the fewer units will remain to accumulate cash values under your policy.

6. Can you sell your units at any time like unit trust?

Yes, you may, perhaps with certain charges. However, if you sell some of your units, you may not adequate to sustain the level of cover that you need.

Conclusion

So, is investment linked insurance product a good choice? It can be especially to the younger person whom has limited budget to buy a traditional term life insurance, which might cost significantly more premium than for the same protection. However, if you can afford, and insurance protection is a significant objective, I will strongly recommend you to consider other insurance options in view of the potential risk of compromising the protection coverage due to poor fund performance. If your primary objective is for investment, then go for a 100% investment focus channel, like Unit Trust. Don’t let the attractiveness of having it all (investment + life protection + low premium) blind you!

p/s: Just a disclaimer, here   I am merely share with you my personal point of view based on my knowledge of the topic. I am not a qualified insurance agent. Hence, do consult the professional for any of your decision made.