Reading into my Investment Linked Policy (ILP) - Part 2

In Part 1, I explained at a very high-level how ILP works and highlighted two important risks that are often overlooked. I also overlooked it when I bought the product. As I am writing this, I am also in touch with my agent to learn more about the product to see how I can "save" my product from becoming trash because I hope to lead a good (and long) life. You will understand why I describe it as trash by the end of this article.

This only applies if you have an insurance component to an ILP. For example, life insurance, terminal illness and disability, crisis cover and early crisis cover.

Risk 1: Vary Premium
Risk 2: Reduction in Yield

Big Idea: Insurance premiums are deducted from the accumulated premium you had paid to the ILP seller. In the initial years, you pay more than what is deducted. In the later years, you pay less than what is deducted, but the balance is covered by the excess that had been accumulated. At some point in time, there will not be enough to pay for the premium. What you pay for is what the insurer calls mortality charges.

Mortality charges is a fixed rate determined by your age, gender, and whether you smoke, for every $1000 insured. This is independent of the premium you pay or the age you start the policy. The age you start the policy and the expected sum insured required will be reverse engineered to a premium such that the break even cost looks good on the benefit illustration.

An extract of how the mortality charges look like is shown below.

I transcribed the numbers into a spreadsheet to do a simple break-even chart. The yearly premium listed is the insurance premium based on a benefit sum assured of $100,000 for each condition (Death, Critical Illness, Early Crisis). My yearly premium is $2,699.

Three rows had been highlighted, which basically showed three potential outcomes of the policy. For ease of explanation and understanding, I had left out sales charge and monthly $5 admin charge, but it will be there.

At 55 years old, the insurance premium of $2,727 will be more than my premium of $2,699. I would be inadvertently forced to stop my early crisis insurance coverage if I do not want to top up the short fall. While the agent's argument is that the accumulated investment returns over the past years could cover the premium, I am skeptical (but more on that later).

Assuming I stop my early crisis coverage at 55 years old, I would be faced with a similar decision point at 65 years old, when the death and critical illness coverage premium will cost $2,938, more than the $2,699 premium. Hmph, so I may be forced to stop my critical illness coverage.

Dividing $100,000 by $2,699, excluding projected returns and charges, a break-even point is at 37 years old, which is 32 + 37 = 69 years old in my example. This is a hide-cash-under-pillow scenario.

Assuming I stop my critical illness coverage at 65 years old, so that my policy can still be active, and if I check out of this world at 69 years old, I would probably just breakeven and have been no worse off with hiding cash under my pillow for 37 years. I potentially could have some cash value remaining in the policy, which I actually do not expect to be much.

At 72 years old, my death coverage (also known as life insurance) will cost $2602, which starts to growth rather exponentially. Anything after 69 theoretically means not "worthwhile" because the guaranteed death benefit is only $100,000 no matter how much you plough in. Earlier arguments had also established that it is impossible to think about critical illness coverage after 65 years old, so there really is no benefit to continue with the policy.

Now I come to the last part about why I am skeptical that the accumulated investment returns (also known as cash value) will not be able to cover a lifetime of premiums. If you have a project return that growths in a linear straight line graph, and an insurance charge that grows in an exponential line graph, we cannot confidently guarantee the projected returns cover the insurance premium charges.

Finally, even the benefit illustration provided in the policy document shows it too, although very (smartly) subtlely.

The last line stops at 40, which does not really tell you the whole truth. At 4% projected returns, the cash value will be $9,000. Based on the mortality charge table, you know that insurance premium will cost $10,570, which cannot be covered by the $9,000. This is where Risk 1: Vary Premium enters the picture. I will need to top up the difference if I want the policy to still be active, else it will be terminated.

Finally, at 8% projected return, Risk 2: Reduction in Yield is acted out. If they had really listed the benefit illustration beyond 40 years, nobody would have bought this product.

Revised image as there was a calculation error earlier that showed break-even at 85 years old.

Indirectly, I am expected to check out at 89 years old, and that is actually based on an extremely optimistic projected return of 8% + average 4% sale charge = 12% return. The early crisis charges also stop at 85 years old in the policy document. Just nice.

I will probably have Part 3 after I have managed to "save" my policy. While many people advocate to terminate the plan, switch to term insurance and cut loss early, I am exploring converting this to a pure ILP product without insurance coverage, or minimal insurance coverage, which appears to be the best option at the moment.