In a two-part series, we explore the world of ILPs, or investment-linked plans. In this first part, we talk to asset allocation specialist Brendan Yong and discuss his distaste for ILPs.
Could you give one single compelling argument why ILPs are bad for the average person?
Brendan: It’s just not cost effective. In an ILP, your premium is split between the cost of insurance and the cost of unit trusts. As you age, your insurance cost rises exponentially and the difference becomes quite substantial when you reach the age of 50. Here are a sample of insurance charges from one insurer (click on the image to expand):
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For a basic protection plan worth S$100,000 for a male non-smoker, these are the annual costs of insurance with critical illness insurance charges added.
While you can enjoy lower costs when you’re younger, the insurance costs will exceed your premium in no time and you’ll have to sell your unit trusts to pay for these rising insurance costs.
I’ve compared many different scenarios in my career, and in all instances, the strategy of buying term insurance and investing the difference in similar unit trusts – the same unit trusts that ILPs will go into – always comes up on top.
Are there absolutely no situations when ILPs are somewhat beneficial for the purchaser?
Well, there are two situations when I will recommend ILPs – for a baby or for a young working adult with absolutely no fiscal discipline. ILPs force the person to put in an amount of money every month. The issue with a regular savings plan with a unit trust is that you can stop it at any time. Since it’s more accessible, the person might have the inclination to stop or withdraw the money from the regular savings plan, unlike an investment-linked plan.
However, if you have decent fiscal discipline and possess an interest in investing, then I recommend that you adopt the strategy of buying term insurance and investing the difference in unit trusts instead.
You really don’t like ILPs. When and why did your distaste for ILPs started?
Before I began my career in the financial industry, I already had an interest in numbers and was able to calculate the time value of money. When my insurance advisor at that time recommended an investment-linked plan to me, I took out my financial calculator so that I could compare the charges with term insurance. My advisor’s face turned pale!
Personally, as an asset allocation specialist, I will never implement a plan for my client that I personally wouldn’t buy (Editor’s Note: If you’re considering any insurance plan, always ask your insurance agents whether they possess the plan that they’re selling to you. If it’s as good a plan as they claim it is, then they should have one themselves). I’ve hardly ever recommended ILPs to my clients, unless they are young people with no fiscal discipline or babies!
If ILPs are as bad as you say, then why are insurance agents heavily pushing these plans to the general public?
In my career, when I meet an agent who mis-sells ILPs, he or she is normally either unaware or untrained. Generally, the younger agents are the ones who tend to display a combination of these two factors.
However, there are also unethical insurance agents who are just out to make money whatever the cost, and ILPs tend to provide the highest commissions. Previously, one of my clients met with an agent who is in the Million Dollar Round Table (MDRT) organisation. The MDRT is an exclusive group reserved for top producing insurance agents. So, I told my client to ask this insurance agent a simple question: “Did you buy into this similar strategy? Show me.”
That was the last time my client heard from the agent.
What are some of the other memorable cases that you’ve come across in your career regarding ILPs being mis-sold?
There are three situations when ILPs are definitely harmful to investors.
- When ILPs are sold to older people, generally those above 50
- When the ILP in question has a low protection value and is being sold as an “investment” instead
- When the ILP comes with a high premium and is sold with the promise that “you can stop paying after an x number of years because it will pay by itself”
With these three situations in mind, I distinctly remember two cases.
- A senior member of my church aged 50 asked me to look at his policies – an agent recommended him to purchase an investment-linked plan. To me, it was clear, even from the benefits illustration, that the rising costs of insurance will deplete his cash values. Yet, the agent was still persuading him to buy one. To top it off, the agent selected a China/India fund that was especially risky for someone at his age.
- A friend of mine passed me his policies, asking me to help him review them. I highlighted to him that an ILP policy he was holding, one which he was paying S$36,000 a year for, may cause him cash flow problems. He told me that the agent recommended him to split his current fixed deposit in five years and use the money to fund his ILP. Then, he can stop paying for his ILP using money from his own pocket. The insured amount was very nominal.
Do you think giving insurance agents incentives for more production or higher sales results in unethical or ruthless selling? What do you think should be changed?
To be honest, it’s inevitable that there should be some form of incentive for sales. Insurance is not something you go out and buy, like getting groceries or even clothes. It usually involves someone calling you or approaching you during a roadshow. Will people purchase adequate insurance on their own without these indicators? I honestly am not too sure.
With the new balanced scorecard framework from MAS regarding remuneration for financial advisors and insurance agents, there will be more focus on ethics and documentation. The new Financial Advisory Industry Review (FAIR) initiatives will mean that insurance folks will need to meet key performance indicators that are not just related to sales, such as providing suitable product recommendations and properly disclosing relevant material information to customers. Insurers are now obliged to increase transparency such as providing the actual projected rate of return and not the typical Projected Investment Rate of Return i.e. the 5- and 9-percent they always use.
Vulnerable investors will now have more protection. We’re definitely moving in the right direction.
Personally, I feel that there should be no selling of ILPs to anyone above the age of 50 and for agents to be legally obligated to disclose the actual rate of return. I feel that this will definitely cut down on mis-selling.
Any final thoughts?
I feel that it’s important to explain that insurance companies must make a profit, otherwise the concept of risk sharing will fail. Even a cooperative insurer makes profits. In exchange for your premium, your family will be given financial protection and I think that this is a fair exchange.
It’s a matter of getting the right type at the right amount and value. Therefore, getting advice from a well-trained and ethical financial advisor will make all the difference in the world.
Read the second part of this ILP debate.