What is ILP?
An ILP is an insurance plan that allocates your premium into an investment fund. The investment fund is managed by the insurance company and the returns of which will be credited into the insured’s account. The insurer’s administrative cost and policy fee charges will then be deducted from said account. In a nutshell, you get medical coverage and also cash value (net insurer fees) from the ILP.
Premiums paid to ILP are lower and allocated differently from most traditional life insurances. Premiums from ILP are used to buy unit funds based on the allocation rate set by the company. For the first 7 years, portions of the premiums are allocated towards payments for administrative and distribution costs (Insurance agents commission included); the rest of which is used to buy investment units. After the 7 years, 100% of the premiums go into buying investment units. Insurance charges will be deducted from the units you own.
- Level premiums are paid throughout both ILP insurance policies and traditional life insurance policies.
- In ILP insurance, insurance charges and policy fees must be paid throughout the whole policy while administration and distribution costs will only have to be paid for the first few years until the allocation rate is 100%.
For ILPs, ‘cash value’ refers to the accumulated premiums that were used to purchase fund units. The cash value depends on market fluctuations and fund performance. You can opt to cash out by selling your unit funds should you need spare cash.
Conversely, ‘cash value’ in traditional life insurance refers to accumulated cash from the excess of premiums paid. The excess cash will be placed into a reserve account to be invested. In addition to that, dividends are given to participating policies, should the insured be entitled to one. Once declared, the company will credit these dividends as the insured’s policy’s cash value.
Insurance charges are low when you are young and increases as you get older. In the early years, premiums paid will be higher than insurance charges. For ILPs, insurance charges are deducted by selling off unit funds, thus leaving lesser units available for investment. As the years go by, insurance charges will increase and more units will be sold off to pay for insurance charges.
If the right fund and investment strategy is employed, the compounding returns from the early years will be sufficient to offset the additional insurance charges while still growing in investment value. However, if the investment has been doing poorly (e.g. economic downturn) the investment value will decrease. Do note that the insured is responsible for topping up his/her premiums should the investment crash (becoming unable to cover insurance charges).
However, this hardly happens in traditional life insurances because premiums paid for traditional life insurances are higher than for ILPs to offset the rising insurance charges.
Also it is important to note that the difference of cash value security between ILP and traditional insurance. In ILP, the risk is transferred entirely to the user in the form of unit trust. Your cash value could do well this year and lose everything the following year. In traditional insurance, your cash value is built up gradually over the years providing a secure pool of funds. Furthermore, you can choose a participating insurance policy (par) where you will reap financial dividens from the company’s profit. This is part of the reason as to why ILP is cheaper than traditional life insurance.
Other minor differences between ILP and traditional life insurance:
While both traditional and ILP insurances have their own benefits, it is essential that you pick the right policy for your portfolio. If you’re looking to go for short term coverage then perhaps ILP is best suited for you. If you want something stable and consistent throughout your policy tenure, then traditional insurance may be the better choice. It could even be both! Just remember to measure your finances, talk to as many agents as possible and to not get into more than you can handle.