Investment-Linked Policy (ILP) vs Participating Life Policy (PLP)

When buying insurance products with investment components, it is important to know what you are buying

When buying insurance, if protection is the only priority, then the most suitable products would be term policies, these being the cheapest because there’s no investment or savings element.

However, many people know that besides providing protection, insurance policies can also help to save and grow wealth.  These policies will cost more because a portion of the premiums paid will go towards investing and saving.

The two most common insurance products in the market that combine both these goals are investment-linked policies (ILPs) and participating life policies.  These products are typically used for investment and wealth accumulation.

At first glance they may look like they both serve the same purpose of helping you grow wealth.  But what are their actual differences, and how should you choose between the two?

How do ILPs work?

When you purchase an ILP, you are essentially buying units in a unit trust.  Some units are then sold to pay for the insurance component as well as other charges such as fund management fees and the rest remains invested in the unit trust.  ILPs have cash values which are dependent on how well your funds perform.  For this reason, the cash value is not guaranteed.

The first and most important point to note is one that is usually not appreciated by many ILP policyholders: the responsibility for deciding which unit trust, or “sub-fund’’ to invest in typically rests with the policyholder and not the insurance company.

This is an important point to bear in mind because if the fund chosen does not perform, then it is up to the policyholder to switch out of it.  Here’s why this is important.

While you are paying the same monthly premium throughout the life of the policy, the cost of insurance typically increases year on year because as you get older the risk of death, disability and illness increases.  This is even if you maintain the same coverage or sum assured.

This means that more units may have to be sold to pay for the insurance charges, leaving fewer units to accumulate cash value under your policy.

If you have a combination of high insurance coverage and a poorly performing sub-fund, the value of your units may not be enough to pay the insurance charges.  You will have to top up your premium or reduce the coverage, otherwise the policy could lapse.

Here, it is important to note that not only are cash values not guaranteed, so is investment performance.  Also, when it comes to investing in a unit trust, past performance should not be taken as a reliable indicator of how the fund might perform in the future.

In short, although ILPs offer the possibility of high returns provided the fund chosen does well, they come with a sizeable amount of investment risk because in the worst-case scenario, the policyholder can lose the entire value of the investment.

This means that investing in an ILP requires active monitoring on the part of the policyholder because all the investment risk is borne by the policyholder.

In other words, if your priority is protection and you are not familiar with how unit trusts work or if you are unsure as to how to select a suitable fund, then perhaps ILPs are not for you.

How do participating life insurance policies work?

When you buy a participating life insurance policy, the portion of the premium which you pay that goes towards investment or savings enters a fund known as the participating or par fund for short and the responsibility for managing the fund rests with the insurance company.

A typical par fund would be invested in government and corporate bonds, equities, property and cash.  The proportion invested in each asset class (often referred to as the investment mix) may change over time, as determined by the insurer.

Participating endowment or life policies share in the profits of the company's participating fund.  Your share of the profit is paid in the form of bonuses or dividends to your policy.

Note the fundamental difference between these policies and ILPs: whilst the investment portion for both groups go into professionally managed funds, for participating life and endowment policies the policyholder is a passive investor with no say as to where the money is invested, whereas for ILPs the choice of funds rests with the policyholder.

Returns for participating whole life and endowment policies tend to be modest compared to the potential returns that ILPs can generate.  However, as noted earlier, ILPs come with much greater investment risk and require active monitoring on the policyholder’s part.

When deciding on a policy that offers investment returns, it is therefore important to know exactly what you are buying.

Note:

For free and unbiased financial education on personal investing, you can visit the Institute for Financial Literacy (IFL). IFL provide talks and workshops to the public and do not promote financial products. Their financial education programmes cover basic money management, financial planning and investment know-how.

Disclaimer:

The information presented here is to provide general awareness and educational purposes and does not constitute specific financial or investment advice. Any mention of private or public organisations, reference to products or numbers used, are for the purpose of providing illustrations to help in understanding concepts being presented.

You are always encouraged to consult a licensed financial advisor, relevant government agencies and/or your family before making any major financial decisions.

Credit Counselling Singapore

Published 12 May 2023.