Investment Linked Plans (ILPs) work differently from other insurance plans. Weigh the pros and cons of ILPs carefully before signing up for one.
Unlike whole life insurance, an Investment Linked Plan (ILP) is often described as a plan that can do it all. You’ll get higher returns than with other types of plans, which means you’ll reach your financial goals faster. You’ll also receive insurance coverage along the way, leaving you free to pursue other interests. Sounds pretty good, right?
The fact is, because of the way they are structured, ILPs are not as straightforward as other insurance plans. Read this guide to find out the pros and cons of an ILP.
Advantages of an ILP
- Higher potential returns: An ILP could potentially give you higher returns than other types of policies, such as endowments.
- Premium holidays: You can ask for a temporary stoppage of premium payments. This does not terminate your ILP.
- Flexibility in coverage: An ILP allows you to adjust your insurance coverage as required. However increasing your coverage may require medical underwriting.
1. Higher Potential Returns
When compared to other insurance policies, you’ve probably noticed that an ILP offers higher projected returns. (Most likely, you heard about it from your insurance agent.) This is not hyperbole or some kind of marketing tactic; ILPs really can give you more bang for your buck.
This is because when you sign up for an ILP, you are dealing directly with the market (through the appointed fund managers). You see, the premiums you pay each month are used to buy units in a fund. These units are then held on your behalf, until you decide to redeem them – i.e., sell them off in return for cash.
Depending on market forces, the performance of the fund, and the time you choose to redeem your units, you could end up receiving a larger payout than from, say, an endowment fund held for the same period. If this is so, you’ll have achieved a higher return.
However, just because an ILP gives you higher returns than other plans doesn’t make it automatically superior. The true test lies in how much higher your total payout is, in comparison with how much you have put in.
Consider that in an economic downturn, an ILP that showed a higher rate of return on paper could still barely break even in real terms.
2. Flexibility in Insurance Coverage
Because of the way an ILP works (as explained above), you will have greater flexibility to adjust your insurance coverage as you see fit.
Of the units that you bought via your premiums, some of them are sold to pay for the charges of insurance. Increasing your insurance coverage, then, is a matter of setting aside more units to cover the higher cost of insurance. Of course, this also means that there will be less units invested in the fund, which will impact your final returns.
However, such an arrangement also means that you don’t have to increase your premiums if you want higher insurance coverage. Although, you may be required to undergo medical underwriting (can be anything from a simple questionnaire to a full medical examination) before the increased coverage is granted.
3. Premium Holidays
Another advantage offered by ILPs is the ability to temporarily stop your premium payments, which is handy if you are transitioning between jobs or need to divert your funds to other more pressing financial commitments.
During a premium holiday, your existing units are used to pay for the cost of insurance, as well as any other fees involved in the upkeep of your policy. Hence, you can only opt for a premium holiday if you have enough units to sustain the upkeep.
With a premium holiday, your ILP is kept in force. This is different from other policies, whereby stopping your premiums will result in your policy being terminated – at massive financial cost to you.
Disadvantages of an ILP
- No guaranteed returns: Unlike some other insurance plans, ILPs do not guarantee any returns. This is why it is considered a higher-risk product.
- May have to reduce insurance coverage: Due to the way ILPs work, you may need to reduce your insurance coverage. This could be problematic for some.
1. No Guaranteed Returns
Why an ILP can offer flexibility in premium continuity and insurance coverage, and potentially higher returns, is also the same reason behind its largest disadvantage – returns on your ILP are not guaranteed.
This is not to say that you will definitely lose your capital when you purchase an ILP. Rather, it simply means your insurer is not beholden to provide you with any payouts when you decide to surrender your policy, apart from what your units are worth at the time of surrender.
Depending on your circumstances and your financial goals, this could render ILPs unsuitable for you. If you cannot afford to lose part or all of your capital, you should consider a plan that provides guaranteed returns.
2. May Have to Reduce Insurance Coverage
An often overlooked factor of ILPs is that you may have to reduce your insurance coverage.
The cost of insurance rises with age. As we get older, the risk of certain diseases and conditions increases. Correspondingly, it is more expensive to insure a 40-year-old, compared to say a 20-year-old, for the same condition.
For this reason, you may encounter a situation where your ILP units are no longer sufficient to pay for both your coverage and your investments – even if you are still paying premiums. At this point, you are paying for insurance only, with very little – if any – of your premiums being invested.
Essentially, you’re paying for a glorified (and possibly overpriced) insurance plan with little to no monetary growth. This defeats the purpose of signing up for an ILP in the first place!
In order to free up your units such that your ILP continues to accrue value, you may have to reduce your insurance coverage. This could be a risky move, especially if you’ll be left with insufficient insurance protection.
ILPs Have Their Place in a Balanced Portfolio
Ideally, your financial portfolio should be made up of different financial instruments, which come together to serve all your needs. It is dangerous to have only one or two types of plans, and expect to be fully covered; this holds true for any insurance or investment plans, and not just ILPs.
As we’ve hopefully illustrated above, an ILP offers distinct advantages, but also come with some pretty gnarly risks. To help you plan how best to employ an ILP (or determine if such a plan is even suitable for you), seek the advice of a qualified financial adviser or wealth manager.
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By Alevin Chan
A Certified Financial Planner with a curiosity about what makes people tick, Alevin’s mission is to help readers understand the psychology of money. He’s also on an ongoing quest to optimize happiness and enjoyment in his life.