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What Do You Think About ILPs?

>> Saturday, August 6, 2011

I believe people who are reading financial blogs and articles are mostly the financial practitioners. And many have voiced strong opinions that Investment Linked Plans (ILPs) are absolute junk. Well, I used to have a herd mentality that this was true, but now after some thought, I wish to challenge that.

First and foremost, whether something is bad or not must be compared in context relative to something else. Therefore, apples should not be compared to oranges. It is meaningless to compare insurance with fixed deposits and similarly ILPs with normal Regular Savings Plans (RSPs) or Buy Term Invest the Rest.

Comparing it against whole life (WL) and term insurance plans would not be absolutely appropriate as the objectives are not aligned. ILPs are generally a savings plan with an embedded yearly renewable term plan. So, unlike WL and term where protection is primary, ILPs' protection is secondary. Hence, I would like to compare it with traditional endowments. Of course some assumptions for the ILP are: returns are reasonable, same age, sum assured and time frame of holding the plan.

1. Surrender Value. Although we all know all plans are long term commitments and should not terminate prematurely, but we assume in a worst case scenario that if it happens, which loses less. Endowments generally return zero on the first year, negligible amount on second and third year if any at all, and throughout is normally less than premiums paid even including the non guaranteed portions. ILP front end load plans still do give some minimal amount even during the first year and probably more overall compared to endowments throughout the plan, assuming a realistic rate of return. ILP back end load plans may give less in initial years but are made up for in remaining years. Therefore, ILPs win this category. Investment return is distinguished and will be compared in a separate category.

2. Protection Value. As I mention earlier, this should not be the focus of the plan. Most endowment plans mostly cover a nominal amount and premiums do not vary a lot with age. Whereas ILPs' mortality charges increases with age, less charges are incurred for younger lives. Therefore, this category is a draw, depending on age, ILP win for younger lives and Endowment win for older lives, though this is still very subjective as it is plan and company dependent.

3. Returns. Endowments generally have a guaranteed and non guaranteed amount, hence one normally receives back the full amount of premiums plus the bonuses declared on an annual basis. ILPs have no guaranteed portion at all, so one could potentially lose everything! However, ILPs invests in a diversified portfolio of unit trusts, how often does a unit trust lose so badly that it loses its entire principal? Can the STI really drop to zero? Let's be realistic here, any well balanced portfolio held on a dollar cost averaging basis for 10-25 years (same time frame for comparision remember) should give a return higher than any endowment plan. Therefore, ILPs win this category.

4. Flexibility. Endowments are totally inflexible in any way. ILPs can vary premiums, premium holiday without interest, duration can be extended or shorten depending on achieved returns, investment portfolio can be reviewed and controlled, ability to even top up or withdraw, addition of riders, etc. No dispute here (let's not get into an argument of intangibles like instilling discipline), ILPs win.

Those are about the main categories and ILP is the overall winner.

Apart from mis-selling the plan as short term, high returns, high protection, an apple to apple comparison with traditional endowments yields a good alternative worth considering.

I hope this triggers constructive discussion with experts who think ILPs are total toxic junk, yet advocate endowments.


financialray August 6, 2011 at 4:34 PM  

Hi Lau,

I don't have any ILP or term insurance.
I have whole life and mortgage insurances.
Mortgage insurance is like a term plan.
It covers death and Total permanent disability. Ask for a premium waiver if contract critical illness, for extra cover at a little more cost.

Lau August 6, 2011 at 5:17 PM  

Hi FR,

Well, it's not about having ILPs or not. Neither do I have. Just doing a comparison.

I have WL and term as well, that's for protection. Savings, I prefer to invest on my own, rather than endowments or ILPs.

Mortgage insurance is essentially a term plan, though it is a term plan where coverage decreases.

CI Waiver only waives the PREMIUM, still need to pay the mortgage installments even though contracted CI n not working. I would rather save the extra on the waiver n top up for full coverage.

financialray August 7, 2011 at 9:59 AM  

Hi Lau,

Yes I also prefer to invest on my own.
What do you mean by saving on the waiver and opt for full coverage?
Have I missed out anything on my coverage?

Thank you

Lau August 7, 2011 at 1:46 PM  

Hi FR,

Example, $100k mortgage insurance, $1000 monthly installment, $100 insurance premium, $10 CI waiver on $100 premium = $1110 paid per month.

Contract CI, claim, you no need pay $110 but still need to pay $1000.

Instead, full CI coverage on $100k, maybe extra $50, no need CI waiver already. Monthly is $1150.

Contract CI, claim, you no need pay everything, $0 monthly.

financialray August 7, 2011 at 5:35 PM  

HI Lau,

Thank you for the enlightenment.
This is a good option to consider.
Let me check with my bank.
But it is like buying another WL instead of making the mortgage insurance like a term plan.
For more expensive mortgage insurance and for older persons like me, maybe more than $50 per month.



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