Insurances – Part IV

In the previous article, we talked about savings plan. Insurance-Linked Plans (ILPs) are similar quite similar. For one, they have the same commission payouts to agents.

Many people do not know about ILPs, so when someone told an agent they want a life insurance, many would jump at the chance to introduce a better alternative – the ILP. ILPs work by combining the life insurance portion with an investment portion. You even have riders, which are essentially add-ons, which you can choose to stack with your main plan.

This plan works first by settling your life insurance portion. Put in a certain amount of premiums every year for the basic plan + any rider if you need it, and you get a cover of a certain sum. If I remembered correctly, I put in about $200 per month and got a cover of $100,000 when I was 25.

With this plan, not all the amount of money you put in is used for the insurance cover. There will be some leftover for your investment portions. This is how it works: your premiums are first converted to investment units, where some of them would be used to pay for the insurance portion. The remaining unused investment units would snowball and gain bigger returns over time.

The explanation part by the agent goes like this: When you are young, you do not need to pay so much for your insurance portion. Hence your investment units will be used up only by a bit. As you grow older, although your insurance portion’s premium gets higher, your investment portion in the plan is also sufficiently high enough as you accumulated returns and consistently put in money over the years. By a certain age, your investment portion would already be self-sustaining, earning enough to cover the insurance portion every year with more to spare. At that time, you would have the option to stop your premiums and let it auto-run, or continue pumping in more money for more investment returns.

In fact, there is also the premium holiday option if you decide to use it – stopping to pay the premium for a few years when you are not doing well financially. Your insurance portion will deduct the necessary fees from the investment portion up until it runs dry if you continually did not pay your premiums.

This certainly sounded very appealing, especially to a young person with little financial knowledge. However do take note, as mentioned earlier, your account is running near empty for the first few years due to commissions being paid out, so the premium holiday option is practically not available for you till a few years later. Do take note that this also means that your investment portion will get smaller and smaller. This is especially critical during your early years as your investment portion is not big enough to self sustain.

I fell for it personally and bought a policy at $2400 per year, cutting it off about 3 years later at a $5000 loss. In fact during the time as an insurance agent, I believed in this plan too and was trying to sell it to my friends. As you may already have known, I sucked at sales and did not manage to close any. Thankfully, I did not manage to scam any of my friends intentionally or unintentionally.

On top of having the bulk of your premiums for the first few years going to the agents’ commissions and making cancellation in the early years a major loss, your returns on investments are also not guaranteed. They will draw up 2 percentage returns, eg 5% and 8% returns and tabulate for you the amount you would expect to receive over the years should your investments achieved a certain rate of return.

Now comes an issue – the high cost of getting this type of insurance compared to a term plan if you are just looking to insure your own life and the rate at which your investment actually snowballs. Although earlier I did say that when you grow older you may choose to stop paying premiums and let the investment portion automatically sustain the insurance portion, you will realise that the insurance portion in your later years is very high. If you look at the projections in your policy closely and do the math, you may realise that the investment portion may not even sustain your insurance portion as it gets higher every year. You now have 2 choices – to stop paying premiums and let it run ‘free’ for the rest of your life (deduct from investment portion to fund insurance portion), or to continue paying premiums so that your investment portion is not affected. Whatever it is, you lose.

The term plan cost only a tiny fraction of the cost of an ILP, and if you take the rest of the money to invest yourself, you are more likely to get a higher rate of return. We know that the concept of compounding interests is a very powerful thing, but it takes time for the snowball to get bigger. For ILP, the first few years are essentially worthless. You only start to slowly snowball your wealth minimally 5 years down the road when all the commissions has been fully paid out, and an even longer time to breakeven. Even then, the rate of your return is determined by the insurance company themselves. While you do have some form of autonomy to decide how risky you want your investment to be, but you might as well get a term plan and take the rest of your money to put inside a robo advisor to have it invest for you.

From Investopedia, we have this definition of a robo advisor:

I have personally tried robo advisors, but it was not very appealing for me. I would rather put my money in some other financial instruments. Some of my friends said it worked for them though. This is another separate topic which I may decide to write an article on in the future.

In conclusion, there are some who swear by the ILP. But personally, I think such policy is trash. Do take a careful look at the mathematics behind it and you will understand. Agents know the math very well, but they hope you do not. If you do not take the effort to help yourself, nobody will. Fine prints and extensive calculations are made complex so that you do not want to read, yet at the same time everything is in black and white so you have no case to argue.

Be diligent. Help yourself.

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