You will be able to explain how an ILP uses premiums to buy units and how charges are taken from them.
When Jun Hao hesitated over the whole life plan, Ryan offered an alternative: an investment-linked policy with the same S$200,000 of cover for the same S$4,000 a year, with "more upside" because the money goes into funds Jun Hao could choose. The ILP illustration looked better than the whole life one at the higher rate, and worse at the lower one. Jun Hao wanted to know why the two rates gave such different stories, and whether the cover itself was safe.
Lessons 5.1 and 5.2 of Unit trusts, robo-advisors and managed money compared, An ILP is insurance and funds in one policy and The charges that set ILPs apart from unit trusts, explain the basics. This lesson takes the next step: how the death benefit is built, how the cost of cover is worked out, and how an ILP can run out of money.
An ILP turns your premium into units in one or more sub-funds. In some policies the full premium buys units from the start. In others the premium allocation rate, the share of each premium that buys units, is low in the early years and rises later, and the rest pays for distribution costs. Read the allocation table for the first ten years.
The units make up your account value, sometimes called the policy value. From then on the insurer takes its charges by cancelling units, usually monthly. Typical charges include a policy or administration fee, an insurance charge for the cover, sometimes a charge on the account value, rider charges, and the sub-funds' own management fees, which come out of the unit price rather than by cancelling units. If you leave in the early years, a surrender charge may come off what you get back.
Together they mean the account value grows more slowly than the sub-funds do.
ILPs pay out on death in different ways, and the design changes the cost of cover.
In one common design the policy pays the higher of the sum assured and the account value. As the account value grows, the insurer has less of its own money at risk, because part of the payout is your own account. In another design the policy pays the sum assured plus the account value, so the insurer's risk stays at the full sum assured whatever the account does. Some ILPs focused on investment pay little more than the account value on death, so they provide very little cover at all.
The product summary states which design you have. It matters because the insurance charge is usually worked out on the sum at risk, the amount the insurer would pay on death beyond your own account value.
The insurance charge is the sum at risk times a rate for your age. The rate rises every year, slowly at first and steeply later, for the reason lesson 1.2, Why premiums rise with age, and how level premiums hide it, explained. An ILP is effectively stepped cover inside a level premium.
Here is a worked example with invented rates, not any insurer's. Suppose the yearly charge is S$1.00 per S$1,000 of sum at risk at age 35, S$3.50 at 50 and S$12.00 at 65. Take S$200,000 of cover on the "higher of" design.
At 35 the account holds S$5,000, so the sum at risk is S$195,000, and the charge is 195 times S$1.00, or S$195 for the year. At 50, with S$30,000 in the account, the sum at risk is S$170,000 and the charge is S$595. At 65, with S$40,000, the sum at risk is S$160,000 and the charge is S$1,920.
On the "plus" design the sum at risk stays at S$200,000, so the same rates give S$200, S$700 and S$2,400.
Either way, the charge at 65 is roughly ten to twelve times the charge at 35, and it keeps rising after that.
Put the pieces together and you get a level premium paying for charges that rise with age, out of an account that moves with markets. In good years the account grows faster than the charges take from it, and in poor years it falls while the charges keep coming.
If the account value falls far enough, there aren't enough units to pay the charges, and the policy lapses unless you pay more. That tends to happen late, when charges are highest and cover may be hardest to replace. It is the main reason the ILP illustration looked so different at the two rates. At the lower rate, rising charges eat the account in later decades, while at the higher rate growth stays ahead of them.
So read the illustration to the end, not just to year 20. Find the account value and the death benefit at each illustrated rate for every year shown. Some illustrations show the year in which the account would run out at the lower rate, or note that top-ups would be needed. Ask what you would need to pay, and from what age, to keep the cover in force to the age you want.
An ILP illustration follows a similar layout to the whole life one in lesson 3.2. It shows premiums paid, account value and death benefit, each at the two illustrated rates for ILPs, which are not the same as the par fund rates. It also shows charges. Some show the effect of deductions and total distribution cost as par illustrations do.
Lesson 5.4 of Unit trusts, robo-advisors and managed money compared, Separate the insurance and the investment in an illustration, shows how to estimate total charges from three numbers. Use it alongside the charge list you make here.
Jun Hao went through the ILP product summary and listed each charge in three columns: what it is, how it is taken, and how it changes over time. The allocation rate rose over the first years. The policy fee was a fixed monthly amount. The insurance charge rose with age and depended on the sum at risk. The sub-fund fees came out of the unit prices. The surrender charge fell to nothing after a set number of years. Five lines, and only one of them, the insurance charge, grew every year for as long as he held the policy.
You'll make the same list for an ILP you hold or have been shown, and the column on how each charge changes is the one to fill in most carefully.
From an ILP illustration or product summary, list every charge, how it is taken and how it changes with age or time.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).