Going by the title of our article by itself, we expect a backlash from a large majority of the people working in the insurance industry. Some of these would include people whom we know, possibly friends, and even partners that we work with.
We will be upfront about our opinion. We do not like investment-linked policies. We think they are inefficient as an investment tool and generally only useful for people who are not interested to manage their own finances. If you are reading this article, chances are you are interested enough to manage your own finances and would be better off saying no to an investment-linked policy.
It is okay if you disagree with us. People disagree all the time. We expect a lot of financial planners to disagree with us. That’s fine. But we will share our reasons why we do not like this policy.
If you ever had been to a financial planning session, there is a good chance you would have heard about what an investment-linked policy is. You would have heard about the merits of what it does for your financial health. You may even have bought it, after hearing all the good stuff about it.
At the risk of coming across as deliberately challenging the status quo, we decided we needed to write more about what an investment-linked policy is, and why we dislike it so much. The reason is simple. Consumers in Singapore are being sold such policies all the time, and sometimes without even understanding what is it that they have bought. We think you need to hear both side of the story, not just what the agents are saying.
What Are Investment-Linked Policies?
Investment-linked policies, also known in short form as ILPs, are a type of policy offered by insurance company that includes both insurance and investment components within the policy.
Traditionally, an insurance policy would provide no returns to its policyholders. Insurance has and will always be a cost incurred in return for better peace of mind. For example, we spend money to buy travel insurance in the event we incur unexpected cost while overseas. We spend money on term life insurance so that a payout would be given to our dependants in case anything happens to us within the duration of the policy.
Selling such policies to the average consumers is not easy. It requires a lot of education to convince someone that buying a life insurance is important.
To solve this problem, insurance companies create a hybrid product that allows you to gain life insurance coverage while also simultaneously allowing your premiums to earn investment returns. From the outside, it seems like the perfect product for financial planning. Ensure insurance coverage for today while also growing your investments for your future financial needs.
The Problems With Investment-Linked Policies
There are a lot of problems with investment-linked policies. It’s going to be tedious and a long read, but we will try our best to go through them one after another. Bear with us.
Problem 1: Us, The Consumers!
Yes! Us consumers are a large part of this problem that we created for ourselves. We point the fingers at the insurance agents and companies, but like the saying goes, there are 4 fingers (no fried chicken sponsored link here) pointing back onto us.
Why are we the problem? Firstly, most of us are just not that interested to spend money on insurance policy, even when it is important for us. The best part about that is that some of these insurance (e.g. term insurance) are inexpensive either, which is also a reason why it is generally less profitable for insurance companies and agents to be selling them to us. Yet we still say no to them. We much rather spend a couple of hundreds each year on TOTO and 4D than to buy life insurance.
The other problem we create for ourselves is that we all want to get rich but lack the knowledge or the inclination to learn how to for ourselves (that is why people invest in TOTO & 4D instead). Spending time to learn how to invest takes too much brainpower.
Hence, we, the consumers, prefer the idea of getting an investment-linked policy that allows us to gain returns from our investment, which can then be used to pay for the insurance coverage that we get.
Problem 2: The Commission Based System Our Financial Planners Operate In
Do you pay your financial planner for the time he or she spends meeting and advising you? Probably not.
You see, most insurance agents don’t even earn a basic salary. Not only that, they even spend money buying you coffee during meet ups. They also pay out of their own pocket to the shopping malls for the right to set up a booth to hustle for leads while facing outright rejection 95% of the time.
So who pays them if it is not us? That brings us to our next point.
Problem 3: Insurance Companies Providing Incentives To Agents To Sell High Margin Products
We need to be real with ourselves. If we are not paying our agents, then they are basically salespeople who are being paid by the insurance companies to sell their products for them.
That also means the insurance companies can directly influence the type of products they want their salespeople to sell by providing more incentive for one product over another.
And guess what, it’s the high margin products such as the investment-linked policies that would be at the top of that list.
Technology Has Change The Landscape For Personal Finance
Similar to many other industries, technology has change the landscape for personal finance. And these changes have already arrived in Singapore over the past few years.
For example, during our parents’ time in the past, gaining a well-diversified portfolio of stocks would be extremely difficult, challenging and expensive even for the financially savvy individual. An individual who understands the merits of diversification would need to call his broker and make an order for the right amount of stocks in each of the counter that he or she is looking at. At about $70 per stock, transaction costs would be a bomb for individual investors.
In those days, buying into an investment-linked policy that allows you to gain access to a wide range of mutual funds (also known as unit trusts) would be a reasonable strategy. Yes, there might be a fund management charge (1-1.5%) and commission to be paid as well as other hidden cost, but it is not like the alternative is that cheap either. Plus it is troublesome.
In today’s context, things have change significantly for the better of the consumer. An individual who wants to invest in a pool of diversified stocks can easily buy into an exchange-traded fund (ETF). If they want to invest in specific investment funds, they can buy into these mutual funds directly through a platform such as Fundsupermart. They pay substantially lower charges for essentially the same investments.
Investing Principals To Take Note Of When Considering Investment-Linked Policies
Here are some things that your financial planners may or may not have shared with you. In some cases, they may have informed you on but neglect to explain on the details.
(1) You Bear The Full Risk Of The Investment Made, Investment-Linked Policies Or Not
Just because you are investing through some insurance companies does not mean your investments are any safer. The most important thing your agent should have stress to you is that any losses incurred from the investment is directly borne by you.
Do not get the impression that your financial planner or the insurance companies is somehow responsible for your returns, or lack of. If your investments do well, it’s not because your financial planner was that awesome. If your investments do badly, neither is it because your financial planner was horrible. Yes some agents may give better advice on investment matters than others but ultimately, you are still responsible for your own investment decisions including whether or not to accept your agent’s recommendations.
The only question that remains is whether policyholders understand that for themselves, or whether they prefer to remain in denial and insist that their financial planners are responsible for their investments.
(2) Investing Over The Long Term Makes Sense, But You Can Do It Yourself
One thing that most financial planners will say is that it is better to stay vested in the long run through the ups and the downs of the market. They are right on that.
What sometime happens next is the overselling of the idea that somehow buying an investment-linked policy is the only way to ensure that you are invested in the long run. The concept that “forcing you to invest” is somehow a good thing is push across. They neglect to tell you of the alternatives, such as being able to invest directly to the stock market by yourself.
Just because you did not buy an investment linked policy does not mean you can’t do your own regular investment in the stock or bond market. You can also do your own dollar cost averaging as well if you want to. You just need a little discipline to get started. In return, you significantly reduce your transaction cost of investing through an investment-linked policy. As for the insurance component, just buy a policy separately.
(3) Agents Need To Stay Relevant
Similar to other industries, the way agents operate today would need to evolve to stay in touch with the changing landscape. People can get easy access to information these days and have a variety of options where they can do investments for themselves.
The problem (and that’s only in our opinion, you are free to disagree) is that most agents are equipped with sufficient knowledge to be able to convince their clients that financial planning is important and that their products can offer the solution required.
What they do not continue to advise however is that some of these products, such as the investment-linked policies, are not any better than what an individual can get for themselves out there. For example, an investment-linked policy takes about 10 years to breakeven.
The ironic thing about this is that while agents used to have the incentive in the past to educate their clients and subsequently sell them a “solution”, they are now caught in a situation where those who are financially savvy enough would be able to do the job without having the agents.
So it poses a dilemma. How can we educate the client that financial planning is important but yet ensure they don’t get too independent that they rather just do it by themselves?
We don’t think financial planners are going to be obsolete anytime soon. In many other developed nations, good planners have successfully transformed themselves from commission-based advisor to fee based ones. We don’t see why the same thing cannot happen in Singapore.
To end off, we would like to also share some of the conversation insights that we have enjoyed talking to multiple financial planners met over the past years. Most of these planners we talk are in agreement with us that investment-linked policies are generally not relevant if individuals are savvy enough to do their own investments.
These trusted financial planners we talk to said this. We did not point a gun to force any of them to say it.
Have a question about investment-linked policies? You can consider joining and posting your question in this Facebook open discussion group meant to promote transperancy in the insurance industry.