Reading into my Investment Linked Policy (ILP) - Part 1

As an advocate of knowledge sharing, I will use a Prudential ILP which I bought two years ago as an example to share and educate my readers about an ILP. The approach I am taking will be different from the typical "Why you should not buy an ILP" or "Why an ILP is bad for you" format; instead, I will explain the ILP details in lay man terms.

Be it an insurance policy or an investment policy, underlying an ILP is a model. By model, I mean that you could visualise a mathematical model that has a set of rules.

Rule 1: Customer pays the ILP seller a fixed premium, either monthly/quarterly/yearly.

Rule 2: Premium is used to buy units of the selected fund based on the prevailing offer/sell price.

Rule 3: Every fund has a buy (from you) price or sell (to you) price. Alike money changers, the sell price is always higher than the buy price. The difference between the buy and sell price is also what is known as "sales charge" which what the ILP seller earns.

Rule 4: For the first 3 years (thereabout), premiums the customer pays are partially paid to their agent as commission. This is clearly, but indirectly, stated in the policy document that you sign.

Rule 5: If there is an insurance coverage requirement by the customer, units are used to pay for the insurance premium. How this works is your units are sold back to the ILP seller every month at the prevailing buy price, so you will have to indirectly pay for "sales charge" again.

Important RISKS in a typical 50-page policy document which your agent will probably ask you to accept and sign without really explaining to you.

Risk 1: Premium is expected to vary, but they did not explain what it really meant.

Risk 2: Reduction in yield is expected at 65 years old, but they did not explain what it really meant.

I will explain these two risks in Part 2.

Disclaimer: Neither am I encouraging or discouraging you to buy this product. I am trying to explain this underlying mechanisms of an ILP.