It’s a vicious cycle for investment-linked policies (ILPs).
Many online articles misrepresent them and financial agents don’t want to deal with the backlash from selling them. If one shares what they know about ILPs with their friends, info likely sourced online, it only perpetuates the cycle of untruths. If you read those articles, the question of 'Are Investment link insurance good or bad?' would be rhetorical.
Nevertheless, this article is not about calling out the half-facts financial bloggers are perpetuating, but addressing three common ILP misconceptions. Neither do I aim to sell the answer to the question of whether investment-link insurance are good or bad.
Misconception #1 - ILPs are a terrible investments because of the allocation ratio
When ILPs were first introduced, they were front-end loaded. This means that only part of your premiums went toward investments (based on the allocation ratio). E.g. Only 15% of premiums is used to buy investment units in Year 1.
At first glance, this doesn't look great. The first few years look like a bias towards the insurance company (as suggested by a local blogger). In addition, you lose out on the magic of compounding interest.
Truth:
The front-end loaded ILP structure is outdated and since 2006 too! What you’ve been reading is expired news, even the 2015, 2016 articles. Most ILPs today are back-end loaded i.e. the entire premium goes into investment from the very start. The investment units are then sold off later to pay for fees and insurance charges.
Insurance companies created front-end loaded ILPs for the sake of settling your insurance expenses ASAP, that 's why they prioritise insurance fees first. However, people soon learned that their own investments returns would likely beat the crap out of their ILPs’ (magic of compounding). Furthermore, front-end loaded ILPs ended up being ‘time-bombs’.
Misconception #2 - ILPs are inferior investment tools because its value relies on fund performance
Yes, your ILP’s value is dependent on your fund performance. If the funds your ILP is tagged to underperform, the value of your ILP falls as well. However, that is not a valid point to argue for ILP inferiority. To argue the contrast, if your funds perform well, your ILP value soars.
Truth:
If your ILP value falls, it’s probably because the chosen investment funds suck. The ILP is simply a wrapper around the insurance and investments plans. Don't hate the wrapper, hate the contents.
In addition, insurance companies offer free-fund switching so make use of that. However, do so with discretion. You chose that fund for a reason so any switch should be justified. If you switch the second the fund value drops a little, you could lose a lot of money. Any good investor needs to have a level of risk tolerance. Since ILPs are are long time-horizon investments, you must be willing to tahan little falls to ride out the volatilities along the way. That is basic investing.
Good ILPs wrap good insurance structures and funds together. A strong advisor must be able to explain how it all comes together nicely. If they can, you probably have a winner on your hands. It decreases the probability that your ILP value will fall.
Did you know?
Indian funds trailed US equities for 5 years (’11 to ‘16) and then beat the crap out of them in 2017 to the point of doubling or tripling the performance of US equities. I.e. if you had an ILP with Indian funds, you would have beaten the US market, the most efficient market in the world.
Misconception #3 - You will be burnt by the costs of your ILP because of sunk cost fallacy
The sunk cost fallacy discusses how one can be reluctant to surrender something because of how much effort has been invested into it. For an ILP, this would refer to someone being hesitant to give up their time-bomb ILP because they have paid so much in premiums.
Truth:
The sunk cost fallacy is only applicable if you believe that getting an ILP will inevitably lead you to lose money, which is untrue.
The longer you hold onto your ILP, the higher your bonuses get (depending on what is offered by the company) and the lower fees become. And if you have chosen (and managed) your funds well, your investment account value should not end up at a loss either.
I can't emphasise this enough, ILPs are investment tools for people with long investment time horizons. If you cannot afford to wait 10, 15, 20 years, don’t get involved with one. Chances are you will feel the pinch of the sunk cost along the way, but you must be willing to ride out the duration to plan maturity.
What you actually need to consider when buying an ILP
The purpose of your ILP. E.g. Balanced ILPs vs investment-intensive ILPs
What the most comfortable payment duration for you is
Risk capacity for investment
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Money Maverick