Article from the Meshio.Com
First of all, you most likely already have an investment-linked insurance policy (ILP).
Maybe your agent might not have told you about it, but if you are like many others who has a medical health plan, it is most likely to have been tied with one.
When it comes to ILP, there are many different views on it. Some says it’s the future of the insurance industry (well, to the extend that some companies ONLY have ILP products) while some say they would rather not risk their insurance coverage with investments. Do you still remember why you got yourself an ILP?
Do you understand the risks you are taking all these while as an ILP policyholder?
Also why must your medical card plan be tied to an ILP? I can?? be sure, but I can speculate on a few possible reasons:
1) a medical health plan is a very important defensive financial tool to help you guard against expensive medical expenses. Since the inflation for medical and hospitalization stands at about 6-7% on an average, it?? not surprising that the profit margin for medical health plan is the lowest for the Insurance Companies (IC). So, what better way to rebalance it with a tie-up with insurance policy.
Note: You can take up the medical health plan on its own without tie-up, as I??e explained it in my previous post: Ruling against Profiteering Hospitals.
2) Why an investment-linked insurance policy and not other insurance policy? Well, in case you wonder, they are many other types of insurance policy, such as endowment, whole-life, term etc.
So why the tie-up with investment-linked? It?? a relatively new product and most ICs marketing team decides that the best way to market and ??ducate?? the public is via a tie-up with medical health-plan.
Well, those are just my speculations. No hard feelings yah.
So, how long has investment-linked policy been around? ILP has been around in Malaysia for about 10 years. Most of the established IC carries ILP as part of their product portfolios.On the legal end, here’s how Section 7 of the Insurance Act 1996 describes ILP as:
Contracts of insurance on human life or annuity where the benefits are wholly or partly to be determined by reference to the value of, or the income from, property of any description or by references to fluctuations in, or in an index of, the value of property of any descriptions.
Simply put, an ILP consist of 2 major elements, the insurance elements and the investment elements. Think of it as a hybrid product between Mutual Fund and Conventional Insurance policy. We will go into detail on these elements later.
Investment-Linked Insurance Policy: How Mutual Fund Works
This is one of the most confusing area which a policyholder might face when it comes to understanding an investment-linked policy. I am not implying that it is very hard to understand, which you will find out shortly just how easy it actually works, but it?? how the concept is being explained by insurance consultants that makes a simple concept difficult to grasp.
Now, let?? take a look on how mutual fund works, and why you must understand the concept of Mutual Fund investment before we can go forward.
How Mutual Fund Works
First of all, I am not going to assume you understand how mutual fund works. So if you already know how mutual fund works, you can skip this section.
A mutual fund is a set of portfolio that consists of various counters (companies) that are listed in the stock market. A highly aggressive mutual fund (also sometimes known as growth fund or progressive fund) usually consists of high growth stocks where the money is invested in stocks that are volatile and hence, it?? pretty high risk. An example would be Public Growth Fund.
On the other extreme would be bond or fixed income funds, where the funds invest mainly in low risk investment vehicles such as money markets, government bonds and corporate bonds. The objectives of bond funds are mainly to provide steady growth and to preserve the investment capital, and hence the returns are much less lucrative than that of a growth fund.
Here?? how a basic mutual fund scheme works.
i) First you have the investors money being pooled together into a mutual fund.
ii) Then you have the Fund Manager who is responsible in making sure the fund makes money.
iii) The Trustee, normally an entity like a bank, ensures that the Fund Manager act according to a Trust Deed which has been mutually agreed by all parties. This is to ensure that no hanky-panky goes on behind the boiler room.
Question: Who bears the RISK of profit or loss from the mutual fund investment?
Answer: Fund Manager of course! WRONG! It?? you, my friend. You are assumed to have read through the prospectus of the fund, and have signed on the dotted line that you??e approved your cash to purchase the fund. You are 100%, yes you are reading this right, ONE HUNDRED PERCENT undertaking the risk, not the fund manager. They only risk losing their job if the fund underperforms.
So now, having understood what a mutual fund is, we need to understand how the money we invest is being utilized. Unlike going through a stock broker or a remisier, mutual fund fees are being charged upfront when the units are purchased. This upfront fee is also known technically as the Initial Service Charge. Let?? look at a common buy and sell table for a typical mutual fund.
When an investor like you and me purchase units from a unit trust fund, we are always buying at the SELL PRICE. Yup, I know it sounds a bit confusing, but you will get used to it after a while. Just think of the table as being owned by the Mutual Fund Company, so the transactions is always based on the perspective of the Mutual Fund Company. Similarly, when we sell, we are always selling at the BUY PRICE??ot it? Duh??
So in the example give above, say you have RM 100,000. You want to buy into Pacific Recovery Fund. The number of units you can purchase with RM 100,000 will be worked out as follow:
RM 100,000 / 0.4936 = 202,593.1928 units
Let?? say the Fund Manager for Pacific Recovery Fund has been performing very well, one month later you have got yourself 300,000 units, and for the sake of simplicity, we refer back to the same chart again, your 300,000 units will be worth:
300,000 units * 0.4618 = RM 138,540.00
The difference between the BUY and SELL price is the Initial Service Charge. There will be other charges that you will be paying for, as some of you might be worried if there are any other service charges, annual management fee, agent commission or even hidden fees! That?? that! You only need to watch these two set of numbers- BUY and SELL.
Next, we are going to talk about how Mutual Fund is being applied in the Investment Portion of your Investment-linked Policy.
Investment-Linked Insurance Policy: Premium Allocation
In this section, we are going to see how Mutual Fund is being applied in an investment-linked policy.
Let?? say you??e just started an investment-linked policy with Never-Say-Die Insurance Company. This investment-linked policy provides you with a few types of funds to invest your money in. These are the available funds from Never-Say-Die Insurer.
a) Coward Fund (very secure)
b) Half-assed Fund (a balanced fund with a bit of bonds and some equity)
c) Black Jack Fund (very aggressive fund)
Let?? say you are a very aggressive investor and decides to invest in Black Jack Fund. Your premium for the policy is RM 200 a month. However, not 100% of the RM 200 you are paying will go into the fund, at least not for the first few years! The RM 200 will be split according to the terms that is stated by Never-Say-Die company, where one portion will go into the investment and the other into the administrative charges.
So how many percent of that RM 200 is going to be allocated into Black Jack Fund?
Let?? just use the following list for this discussion:-
Funds allocated for investment into Black Jack Fund.
1st Year: 40% (RM 80)
2nd Year: 50% (RM 100)
3rd Year: 80% (RM 160)
4th Year: 90% (RM 180)
5th Year: 95% (RM 190)
6th Year: 100% (RM 200)
7th Year: 100% (RM 200)
So, in other words, you are going to be paying RM 16,800 of premium for the first seven years, and only RM 13,320 will go into Black Jack Fund. The rest of the premium will be allocated for the administrative charges. Of course, after the 7th year onwards, the allocation for investment will stay put at 100%.
One very important thing to note is that the more money you have in the fund, the harder your premium is working for you. But you must always keep in mind, this is an investment and it carries with it the risk of losing money. Still remember who?? going to bear this risk? You, my dear policyholder! If you make some clean profit, congratulations! If you suffer losses from the fund, don?? blame the company, you authorized the investment, remember?
For those who are curious about the actual premium allocation for various insurance companies in Malaysia, here?? a summary breakdown for the first seven policy years.
The information might be outdated, and if you find any inaccuracies, please let me know!
This is one reason why an investment-linked is never a good idea to be used as a SAVING policy unless you are prepared to contribute extra premium which will be allocated specially for investment purposes. Similar to any investment vehicles out there, your investment funds is subject to growth and losses, based on the performance of the underlying investment activities of the funds. Hence, to ensure that your investment-linked policy meet your financial objectives, the premium allocation must be carefully planned and structured and not leave everything to chance.
So what?? going to happen to all the units that are being bought using your premium? We shall cover that together with one of the most important topics and also one that is often not clearly stated, if it?? stated at all during the sales of an investment-linked policy- Insurance Charges in an Investment-linked policy.
Investment-Linked Insurance Policy: Insurance Charge
So, what’s the big deal with the insurance charges? Well, I am going to cover exactly that, with a little bit of simple maths, don’s worry, no algebras!
Unknown to most, even to the sales personnel that has been recommending investment link products to unsuspecting clients, insurance charges in an investment-linked policies are calculated according to a rising rate. Note the keyword here- rising rate. We will discuss later how this rising rate will affect you not now, but a few more years down the road.
Insurance charges are the cost that is incurred by the Company to take up the risk for a particular coverage. Insurance charges is calculated according to the type of coverage. All the benefits such as Death, Dread Diseases and Disability has different insurance charges rate.
Below is a set of example I’re taken from one of my existing investment-linked policy. You might need to refer to your policy manual to check up the rates or if you can’s find them in the policy manual, ask your consultant to provide one. This rate is very important for you to calculate if your premium you are paying now is enough for your coverage when you get older.
This is the reason why the premium you are paying for an investment-linked policy is not guaranteed.
For example, say you’re now 25 years old, and you’re got yourself an investment-linked policy with a sum assured (death benefit of RM 100,000).
Based on the figure above, the insurance charges you are paying at age 25 is calculated as follow:
Sum Assured x Insurance Charges Rate / 1,000
100,000 x 1.34 / 1,000 = RM 134.00 per year.
This means that RM 134.00 will be allocated for your Basic Sum Assured (Death Benefit) coverage for that particular year.
Similarly at age 50:
100,000 x 5.37 / 1,000 = RM 537.00 per year.
And at the age of 70, you will need:
100,000 x 29 / 1,000 = RM 2,900.00 per year
just to cover for your Basic Sum Assured (Death Benefit). And this is not including other benefits such as Dread Diseases, Waiver of Premium for Disability/Dread Diseases etc.
While we are at it, let’s also take a quick look at how much your medical card charges will cost you as you get older. The insurance charges table for medical card is shown below in Figure 2.
This figure is much more easier to read, since you can get the total insurance charges for the year you are looking for directly from the chart.
For 25 years old, your medical card coverage will cost you RM 238 yearly in insurance charges.
For 50 years old, similar medical card coverage will cost you RM 438 a year.
And finally at age 70, you are paying RM 1,651 a year for the same medical coverage.
Okie, that’s all for the maths. Now, you might be wondering, “How then, my premium is not guaranteed?” Or you might rebut, ‘rey! I was told very clearly that my premium is fixed!’s You are both right and wrong.
Let’s take a look again at the two tables above. What do you notice? (observe harder’s
Well, you should realize that in the beginning of the first few decades, your insurance charges remain pretty much level. This is the optimistic era of your life, where everything is going well, hopping from one good job to another, driving new cars, moving into new house. Everything is sunshine and lovely!
As you approach mid-life crisis, that’s when the rise of the insurance rate charges kick in, of course, to add to the crisis!
The investment-linked policy is a product designed in such a way that it allows you to buy a very huge sum of protection in the early years with very minimal premium. By now, you should know why. I have seen cases where people can get RM 300,000 protection with a mere RM 150.00 monthly premium. Consumers who don’s read this article will think that they are paying RM 150.00 a month until Kingdom Come.
The Old Age Dilemma
As you get older and wiser, evidently the insurance charges will continue to increase dramatically.
When the premium is not enough to cover, you will receive a letter from the Company to remind you that you either top-up your premium, allow the Company to channel the profits (if any) that you’re made from your investment to cover for the rising insurance charges or in the worst case scenario- terminate the policy.
If your retirement budget does not include this portion of expenses, you either let the policy terminate or you will need to adjust the coverage down to a level where you can afford or remove some of the benefits. Not a good idea, since the older you get, the more you need the coverage.
This is why you might be told that your premium is fixed, but at the expenses of adjusting your coverage/benefits.
Conclusion
That’s why it’s important that one understand the nature of an investment-linked policy before signing on the dotted line. An investment-linked that is tied with many features and is financed with minimal premium is not meant for investment or savings purposes since most of the premium paid by the policyholder will be used up to pay for the insurance charges. Its core function is for protection only. If you are looking for investment return from your investment-linked policy, consult your insurance adviser on how you should allocate your premium.
Ensure that you are not being taken for a ride with the low premium high protection concept! Traditional insurance policies are the only GUARANTEED REGULAR premium insurance products. The premium and insurance charges has been calculated and averaged throughout the entire policy life. This is the reason why traditional policies are slightly pricier than their investment-linked counterparts.
A better risk management strategy would be to ensure that you also have traditional policies covering your life alongside the investment-linked policy. An ILP should be used mainly for your medical card coverage.
What about those who found out that they can’s afford the sudden hike of insurance charges and decided to start a traditional policy? Definitely not a very good idea especially if you realized this problem when you are about to retire (55 years old and above). The premium for any insurance products at that age will be prohibitive.
And that’s that. I am going to wrap up the entire series on Investment-linked Policy with the following advice:
There’s no way you can get high protection with low premium, at least not for long. Ensure that your consultant give you the whole picture of the policy terms, including insurance charges and risk profile of the fund. If the plan is too good to be true, it probably is. Remember, there’s no free lunch!
Article from the Meshio.Com
