ILPs: Are they good or are they sh*t?
The answer, like most things in life, is – it depends.
Before reading on, I’d like you guys to know one thing - I thought a lot about the repercussions of writing such an article at length before publishing it. However, having had first-hand experience in the industry learning from the best, I feel it is my duty to do so.
If you have seen my previous article “The Moral Dilemma of Entrepreneurship” (in my industry), you will understand why I’m writing this.
Link to the article: https://www.dollartainment.com/post/the-moral-dilemma-of-entrepreneurship
Some straight talk to ease you guys into things
Investment-linked policies are, let’s face it, demonized consistently by a public that have had bad experiences with conniving agents.
They promise you high returns without actually knowing how their own plans work, much less actually knowing how to construct a portfolio. Trust me, as someone in the industry who has seen plenty, I completely understand.
Typically, the only real angle they have to sell with is the strength of their salesmanship.
Hefty welcome bonuses and perks are mentioned, large investment premiums recommended, and last but not least, annualized returns and the final account value after committing to the plan are exaggerated.
Everything sounds good but there is no record of anything the adviser has promised you. It is simply a nice bubble created by good salesmanship.
However, that is not to say the plans themselves are bad. Saying an ILP is bad is like saying ‘guns are bad’ or that ‘money is the root of all evil’ – both are not true, by the way.
Anyone who has survived a home invasion because they owned a gun would tell you otherwise, so too would the self-made person who hustled their way from poverty to riches.
On the flip side, if you are an idiot with a gun, you are going to hurt yourself and others. If you are an A-hole with a lot of money, you’re just going to be a bigger A-hole.
Similarly, ILPs are detrimental only in the hands of people who either mis-sell them or people who don’t understand how they work.
Like anything else, you need to know what you are getting into. No salesmanship should be taken seriously without a healthy dose of numbers and facts.
This is the FINANCIAL industry, after all.
Something people often forget – not just clients, but practitioners themselves.
So without further ado, let’s get into how they work.
ILPs, or investment-linked policies, fall into 2 broad categories:
1. Protection ILPs
2. 101 ILPs
To further complicate things, ILPs come with numerous fee structures, mainly:
1. Front-end loads (upfront sales charges typically about 5%)
2. Back-end loads (you get charged when you take profit)
3. Annual charge
In order to keep this article streamlined, I will be focusing on ILPs with annual charges rather than those with sales loads. These fee structures are also the most favorable to the client as well (in my humble opinion).
What do I mean by this?
Sales charges don’t incentivize the fund manager to perform. They receive it as a one-off commission and then they’re off on their merry way to invest your money.
Annual charges, on the other hand, also aren’t entirely aligned in terms of interest because the manager still gets paid regardless of performance.
(Oh no, the financial industry isn’t entirely aligned with consumer interest? Gee whiz, what a surprise!)
On top of that, it might be more costly in the long term for the investor.
However, it does give the fund manager much more incentive to perform.
Imagine being a fund manager. You go to work all dressed up nice and peppy, or not (sometimes you don’t because you’re extremely rich and wealthy so Metallica T-shirt and faded jeans Bobby Axelrod style is fine). But either way you need to deal with charts, digits, Bloomberg terminals, macro trends, micro trends, technical analysis, fundamental analysis, targets, quotas, managing a team of analysts… and somehow still have a life outside of that (hint: most of them don’t).
(On a side tangent, here's a pretty funny article which covers dress codes in finance and what they mean. You're welcome.)
Imagine having your annual income decrease every single year because your AUM (Assets Under Management) keeps falling due to your own ineptitude and your annual performance bonus decreases every year because you are unable to grow the pool of money you were tasked to manage.
Talk about a bad deal.
On the flip side, an ambitious and capable fund manager is going to leverage on this system to make sure they invest your money properly so they keep earning more every single year by growing the pool of money under their management.
This means that the discerning investor should look for funds which have strong annualized returns despite multiple changes in management. No fund that has been around since the 90s will have had the same manager and team all the way.
Protection ILPs capitalize on investing most of the premiums paid when your cost of insurance is low (if you enter young). This is in order for the investment returns to not only cover the significantly higher cost of insurance as you grow older, but to deliver you additional returns on top of what a whole-life policy would.
101 ILPs are meant for outright investment returns. If there is one product in the insurance industry that is meant to actually make you money and nothing else, this is it.
But this is only if they are properly structured, taking into account fund performance and fee structures to deliver a satisfactory, net-of-fees return.
This presupposes several things:
1. Your adviser is competent enough to select funds with strong fundamentals that match your risk appetite, investment goals and time horizon
2. Your adviser understands the policy fees and charges
3. He has a conscience and is willing to explain all this to you at risk of him earning a lower commission
(If you’re having doubts at this point, don’t worry. We can be jaded together over coffee/dessert.
But no, it's not impossible.)
To put it simply, Protection ILPs come with a Sum Assured – for which you need to pay a cost of insurance on top of the policy fees and charges. It is because of this Sum Assured element that I classify such ILPs as Protection ILPs. By purchasing this policy, you are investing the significantly higher upfront premiums when the cost of insurance is low to ensure that the policy becomes self-sufficient with the investment returns in the future.
It pays for your cost of insurance and then some.
Whereas in 101 ILPs, there is no sum assured. This kind of policy is NOT meant for protection. Do NOT expect a massive lump sum payout from these kinds of policies because that’s not what they are designed for.
Think of it as a wrapper, a unit trust with a lock-in period to ensure you stay disciplined and not get your hands itchy to touch your investment money before you achieve your financial goal.
The Death Benefit in the event of the client’s death is either the Account Value or 101% of Total Premiums Paid, whichever is higher. Basically it is capital guaranteed upon death – of which it is important to note that no other investment instrument has such a function. Hooray for life insurance companies.
Incidentally, that’s also how they earned their monikers of 101 ILPs
In other words, you need only to pay a cost of insurance if the policy falls below 101% of the total premiums paid (TPP) (Depending on the insurer you purchase the policy from, it could also be 105% or 110% of TPP). Otherwise, because your account value is being returned back to you upon death, you are effectively self-insured and will not need to pay any cost of insurance.
Therefore, for all practical purposes, there is no cost of insurance on a 101 ILP because the adviser literally needs to screw it up so bad the policy can’t even net a return higher than 1% every year to be above the 101% of TPP criteria.
If your 101 ILP is charging you for insurance costs, something has went horribly wrong (read: your investment has gone to sh*t).
Conclusion: If you are looking for a platform to actually generate investment returns to write home about, what you’re looking for is a 101 ILP, NOT a protection ILP.
Assuming both ILPs are able to invest in the same funds which have the exact same returns, a protection ILP is still going to lose out to a 101 ILP simply because of how they’re structured:
Here’s a cost of insurance table from your typical insurance policy illustration:
For the purposes of this illustration, let’s assume the client is a 30 year old male (non-smoker).
*Policy charges are usually charged on a monthly basis, but for simplicity’s sake, I’m calculating everything on an annual basis.
Now some of you might say the investment returns are less than ideal, which, if you consider the fact that your 11.73% 10-year annualized return of the S&P500 Index from 2010-2020, you would be right.
But if you look at the intended purpose of a protection ILP, which is to beat the annual returns of a whole life insurance plan (typically about 3-4%), then the protection ILP is a resounding success.
Now let’s look at a 101 ILP and the kind of magic it can create for a client’s portfolio.
This is the 1 year return of one of the funds available in the market which some clients have within their portfolios:
Now time for some quick math:
*The actual value here is much closer to 160% as policy charges are deducted monthly. The calculation of charges here is flawed because it assumes that everything is deducted as a one-off fee at the end of the year. In other words, it is just an ESTIMATION.
In actual fact, how it works is that every month 2.5%/12 = 0.20833333% of the Account Value is deducted. What this means is that you get charged less on months with lower performance and higher on months with better performance.
P.S. Please do not expect this 1-year return to repeat itself consistently. It had a strong post Co-Vid recovery and completely trashed the S&P500, but as they say, past performance is not indicative of future performance.
The above figures are purely an illustration and not a guarantee of any sort of investment return.
That being said, I hope this post helps to provide a fresh, constructive perspective on how ILPs can be used to optimize an investment portfolio as well as the purposes of each type of ILP.
It is not helpful to be on either side of the fence, where as an agent you blindly believe that every product you sell is perfect (some are just horrible), or on the flip side - believing ILPs are crap from having encountered your typical agent that gives this industry a bad rep.
Instead, I encourage consumers and advisers alike to actually study what they sell, the mechanics behind how it works, and to put in the effort to creatively express their knowledge so that everyone benefits.
Dollartainment is the brainchild of one Erdem Ong, a licensed financial consultant under MAS, the Monetary Authority of Singapore, for PIAS (Professional Investment Advisory Services). The opinions expressed here are solely his own and PIAS takes no responsibility whatsoever for the contents of this child (the blog).
His approach and perspective on financial planning involves critical analysis of products and – dare he say it – math. He realized that smiling and nodding patiently at clients and agreeing with everything they say only leads to mutual pain and suffering. The same can be said of life and people.
And from that realization, Dollartainment was born.
This platform aims to serve the community as a resource for members looking to educate themselves on the ins and outs of insurance, investments and personal finance as a whole.
If you need clarification on the contents of the article or your existing portfolio, slide into his dms through the various means available.
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