Investment-Linked Policies (ILP)

I profess not to have much knowledge in the field of insurance, but I recently dusted off some old files and looked at one of the ILPs that was sold to me when I was barely out of secondary school.

In a nutshell:

• You should stay away from these things unless you have an exceptionally clear idea of what you are getting yourself into and why.
• If you are looking for insurance policies, you are very likely to get more cost-effective insurance through term policies (where you pay a small sum every month for coverage).
• If you are looking for investment products, you should probably look elsewhere for something that is more transparent and incurs less fees (e.g. buying index ETFs).

I am in my 13th policy year, and I recently generated a revised Benefit Illustration (BI) for my policy.

In case you are not familiar, let me briefly explain the columns:

• Basic Premiums Paid: The cumulative amount that the policyholder (me) has paid into the policy. For this policy, I am required to pay every month for 21 years. 
• Gross Death Benefit: This is the insurance component of the policy. If the policyholder were to die at age 30, the insurance payout will be somewhere between the range of $39,639 and $45,260. The guaranteed and non-guaranteed portions are pretty much what their names imply. 
• Gross Surrender Value: This is the investment component of the policy. If the policyholder were to surrender (i.e. terminate) the policy at age 30, he would receive in cash somewhere between $19,899 and $20,566. Again, guaranteed and non-guaranteed mean what they say.

You will notice that both the non-guaranteed columns increase substantially over time. This simply reflects greater uncertainty over time. I believe the non-guaranteed columns are typically built on the assumption that the company (the policy provider) is able to generate 5.25% p.a. return on its Fund. If the actual return is lower than this, then you can expect that less than the full non-guaranteed amount will accrue into the guaranteed amount for that year.

I did a quick IRR calculation for two broad scenarios:

1) Immediate surrender of the policy at end of Policy Year 13

I can expect to get around $20,000 upon immediate surrender. Based on this, my "investment" would have yielded -3.1% per year. Yes, negative yield. This is not surprising since the cumulative amount I paid is around $23,500, but I am only getting $20,000 back, after 13 years as a policyholder. Ouch.

2) Holding to maturity, i.e. Policy Year 21

For this scenario, the guaranteed surrender value is $31,239 while the non-guaranteed portion is currently $19,942, summing up to $51,181. Let's assume I get $50,000 upon maturity. The IRR in this case is around 2.5% (per year over the 21-year tenure). That feels 'okay' but nothing fantastic.

What happens if the non-guaranteed portion doesn't do so well, and I only get $40,000 upon maturity? The IRR falls to a very dismal 0.31%. That's not a very good "investment" at all, is it? 

Now, here's the twist:

For simplicity sake, let's assume I have only two options, (A) surrender the policy immediately, and (B) hold the policy to maturity. Let's ignore the fact that I can surrender the policy 1, 2, 3, 4...8 years from today.

In (A), I collect $20,000, and I am unshackled from this policy. I can use this $20,000 to invest in whatever way I wish.

In (B), I forego collecting $20,000 today, I commit to paying ~$1800 per year for 9 more years, and I stand to collect between $31,000 to $51,000 upon maturity. If I collected $50,000, my IRR for this 9-year period is around 5% p.a. Wow, this now looks very appealing! (Note though, that if I collected $40,000 instead, my IRR for this 9-year period is 1.43%.)

So the real question is, if I went for (A), do I think that I can make a return of more than 5% on the $20,000 + the $1800 per year? If I don't think I can do that (e.g. if I simply dumped it into the DBS Multiplier and assuming I could get the maximum interest rate of 3.5%, or even assuming I ploughed it all into Singapore Savings Bonds), then actually, I am better off with option (B).

This set of  rough calculations aim to illustrate a few points:

• It is usually quite painful to terminate an ILP early. The benefits tend to be back-loaded, incentivizing the policyholder to hold the policy to maturity. However, this means an extended period of exposure to the performance of the company's Fund - you have no say over what they do/don't do and you can only hope they hit the 5.25% return over the full tenure (in my case, 21 years) so that the non-guaranteed component fully materialises.
• If I ended up with the $40,000 outcome at maturity, perhaps I would comfort myself that some of the opportunity cost of my money went towards paying the insurance aspect of the policy. That would be scant comfort, since the death coverage (guaranteed component) is not even $50,000 and you can easily buy term insurance for $100,000 coverage at a much lower price.
• Hence, the policyholder is really beholden to the vagaries of the policy (from an investment POV) and is seriously overpaying (from an insurance POV).

I still haven't figured out whether I will continue with the policy, or bite the bullet and suffer the consequences of early termination. The $1800 a year could be easily invested elsewhere, but it entails a certain risk. Investing in essentially risk-free products (like Singapore Savings Bonds) is definitely out, since they only yield 2.x% at present. Even the 4.x% Astrea IV bonds does not look good compared to the potential 5% yield if I stay the course with the policy. 

The main reason why I'm faced with the above dilemma is that the ILP product itself is really quite complex, and demands detailed analysis of one's objectives and time horizon. It is perhaps an unnecessary burden that I want to wish away, but unfortunately am unable to. Now it is simply trying to make the best of the given situation.