In general, there are two types of ILPs — protection-focused ILPs and wealth accumulation-focused ILPs.
For typical protection-focused ILPs, which emerged in the 1990s, premiums are used to purchase units, with a portion then sold to purchase the insurance component, which is usually a yearly-renewable term insurance. The unsold units are then used for wealth accumulation.
Unfortunately, as one gets older, insurance charges increase. Eventually, when premiums are not enough to cover them, units accumulated earlier in the policy have to be sold to fund insurance purchases.
Furthermore, for this type of ILP, a significant portion of the premium in the first two to three years is allocated to distribution costs, which means less premium is used for investment.
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In contrast, most of the premium is invested with minimal insurance in wealth accumulation ILPs, with Tan sharing that the insurance component of newer ILPs may be as low as 1% of the premium.
However, these ILPs typically have high surrender charges, especially during the first few years. In our main story, Eddy Cheong, CEO of independent insurance advisory firm Havend, points out the “huge” penalties for policyholders who wish to surrender their policies early.
Furthermore, the protection offered by wealth accumulation ILPs may not be guaranteed and depends on the account value (or invested amount plus bonuses and returns).
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In addition to the relatively higher annual management fees of ILP funds, there are usually other fees and charges levied by the ILP, including, but not limited to, annual policy administration fees, sales charges for trading units and fund-switching charges.
Despite these drawbacks of ILPs, Tan noted in an online discussion with 1M65 founder Loo Cheng Chuan that there are “relatively” better ILPs that use lower-cost ETFs and index funds, and those with relatively lower fees.
Buy term and invest the rest (BTIR)
“Buy term and invest the rest” (BTIR) is a strategy in which one buys term insurance for financial protection and invests in separate products, keeping insurance and investment separate.
The main thrust of BTIR is for one to just buy “pure” life insurance, or term insurance without surrender value, instead of more costly options such as a whole-life plan or ILP. With the savings from buying cheaper term plans, one should invest to earn a higher rate of return.
For BTIR advocates, the strategy is more cost-effective. With lower overall costs, one may potentially earn a higher return while being protected.
Secondly, BTIR offers greater flexibility compared to ILPs, especially during the early years. For BTIR, one can liquidate investments without penalty. In contrast, early surrendering of ILPs typically has high penalties.
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However, BTIR may not be for everyone, notes Bryan Chan, lead of solutions at Providend. In an article, Chan points out that one may not end up investing “the rest” consistently and could lack the temperament to stay invested “over a long time, across all sorts of market conditions”. Additionally, one may lack the knowledge to invest.
BTIR versus protection-focused ILP versus wealth accumulation ILP
To better illustrate BTIR (buy term and invest the rest), The Edge Singapore has done independent calculations comparing the potential outcomes of three strategies — a BTIR versus a protection-focused ILP versus a wealth-accumulation ILP.
Thomas, Richard and Harold are 25-year-old males who do not smoke. They require $1 million in death and total and permanent disability (TPD) coverage and $200,000 in critical illness (CI) coverage for 40 years. Each of them has $6,000 to spend on life insurance and investment. They each willingly chose a strategy and the instruments and are fully aware of the potential outcomes. They were not misled or coerced into their decisions.
Thomas adopted BTIR and searched for suitable term insurance on compareFIRST.sg, an online portal to allow consumers to find and compare insurance products. It was launched in 2015 by the Consumers Association of Singapore, the Monetary Association of Singapore, the Life Insurance Association of Singapore and MoneySENSE.
From compareFIRST, Thomas chose HSBC Life’s Term Protector policy to cover death and TPD for a premium of $571 annually and Tokio Marine Life Insurance’s TM Assure (II) with a critical illness accelerator rider to cover CI at a premium of $533 per year. In total, Thomas pays $1,104 in insurance premiums per year and invests the remaining $4,896. It must be noted that TM Assure also covers death and TPD, so Thomas is somewhat over-insured for death and TPD. Unfortunately, compareFIRST was unable to provide a quotation for a pure CI policy or attach a $200,000 CI rider to a $1 million main policy. Otherwise, Thomas could have more funds for investment.
Richard chose the HSBC Life Flexi Protector, a protection-focused ILP with the required level of protection. The yearly balance premium, after paying for insurance and other charges, is used for investment. Insurance costs will increase as he ages, so less and less will be invested as he grows older.
Meanwhile, Harold decided to use only HSBC Life Wealth Accelerate, an ILP focused on wealth accumulation. The death benefit is not guaranteed and there is no CI coverage.
For both ILPs, the total surrender value (or net investment returns) is obtained from the benefit illustration of their respective policy quotations. All values include fees paid and bonuses given.
All portfolios invest in funds with similar fund types, holdings, allocations and geographies, among other factors. The key difference is that BTIR uses passive index funds and ETFs (with a maximum expense ratio of 0.5% and front-end sales charges/brokerage fees of 1%), while the ILPs use actively managed funds and incur relevant policy charges mentioned earlier in the article.
This exercise is a theoretical scenario for illustrative purposes only. In real life, there may be more variables to account for, so the figures may differ. Readers should consult a licensed financial adviser to develop a plan most suited to their needs.
Based on the projections, despite Thomas overpaying for insurance and investing less, the BTIR strategy is still the highest-yielding while providing the required level of protection.
At a 4% projected investment return at the end of 40 years, BTIR provides a yield that is 90% higher than the protection-focused ILP and 2% higher than the wealth accumulation ILP.
At 8% returns for 40 years, BTIR’s projected return is more than 64% higher than the protection-focused ILP and 10% higher than the wealth accumulation ILP.
It should also be noted that the wealth accumulation ILP does not provide both a guaranteed death benefit and CI cover.
Throughout each of the 40 years, BTIR is also projected to provide the highest return for each year.
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