*This is a story contributed by Donald Lee, who helped his friend (and client) exit an ILP within 3 years.*
Insurance is a financial instrument that requires a longer period of commitment. Even more so when it comes to Investment Linked Plans (ILP), which has an investment component coupled with protection.
A typical ILP might take up to 8 or more years to break even, beyond which the policy owner really reaps the benefits of such a plan. But what happens when you decide to call it quits way earlier than that?
My friend approached me with just that sort of a scenario back in 2009.
Left high and dry after Agent quit: 3 months in
Kay bought an ILP back in early 2009 from his agent who was also his friend. But the agent-friend left the industry after 3 short months. Kay sought advice from me about what to do with his policy.
(Editor: Quite a number of people start off with ILPs first, which in our opinion is not the right policy. It takes acute market knowledge and financial savvy to combine investment with protection, which is why we do not support such a notion. Even if the financial planner claims to be able to manage the portfolio, many a time they do not. The policyholder is then left high and dry)
He did another round of pros and cons about the policy and decided not to keep it, opting to go for a Whole Life Plan instead which would take care of his death cover and critical illness needs more fully.
At this point, the monthly premium was $200 and he already paid for 3 months. If he surrendered the policy at this point, he would lose all $600. Kay asked what could be done if he wanted to walk away unscathed, instead of suffering a “pointless” loss.
Willing to top up – and the market was willing to cooperate
Kay was willing to continue to service (ie pay for ) the policy until it at least broke even. I then suggested that in this case, he could pay for the premium “upfront” first. The technical term for this is called a Top-Up, which came with the advantage of allowing more of the premium to be used for investment, compared to the monthly premium mode.
I suggested this largely also because of the market crash in 2008 (it was early 2009 back then), so equities were still in the recovery phase. Instead of dollar cost averaging, we would be buying units that were cheaply priced, and thus accelerating the recovery process.
Kay liked the idea very much and finally decided to pay up another 2 years worth of premium ($4800). The advantages were twofold and compounded each other:
- By doing a top up, 92% of the premiums would be used to buy investment units. Compare this to 15% of the regular monthly premiums.
- Cheap market conditions meant that Kay could then purchase far more units than usual, compared to dollar cost averaging. We expected the market to recover.
The unit trust portfolio consisted of 75% Asian equities and 25% Global bonds. On hindsight, the unit trust chosen was not the best – but the timing was impeccable. John F Kennedy would attribute this to a “rising tide which lifts all the boats”.
With that, Kay decided to stop his monthly premiums and did a full 2-year Top-Up. The paperwork back then was simple and consisted of a few pages.
All’s Well that Ends Well
When we revisited the portfolio one year later in 2010, Kay was pleased with the returns and decided to do another top-up, this time to the tune of 1 year’s premiums – $2,400.
Beyond that, he did not commit any more premiums and managed to exit the policy happily before 36 months were up. This table shows the timeline of events and portfolio value up till 2012, when Kay broke even and surrendered the plan.
Circumstance had a big part to play
The portfolio grew approximately 8% annually, which is a decent rate but nothing fantastic considering the market crashed heavily in 2008. (Ed: Returns of 50%, 60% were normal for that recovery time period).
This let the portfolio grow decently over the course of 3 years, letting compount interest work its magic. This feat can probably be repeated, but the breakeven period will differ due to the market conditions we face now.
Play the game with full knowledge of the rules
The market was a big factor, but knowledge about the mechanics of ILPs was equally important. By doing top-ups instead of the regular premiums, it greatly increased the efficiency of the plan. This was only possible with a proper understanding of the policy structure, and taking into account of Kay’s situation and the investment market.
Walk in with your eyes wide open
Still, I believe this story should be an exception rather than the norm. We should only commit to policies after thoroughly understanding them, rather than change our minds after a short span of time. To avoid instances of this happening, work with a trusted financial adviser and properly understand the motivation of the plans you commit to.
We never liked the idea of combining insurance with investment. There are far too many charges and fees to make the whole concept efficient. Kay’s happy ending notwithstanding, there are far more people with less than satisfactory outcomes with ILPs.
Note that Donald was helping Kay in the capacity of a friend, since Kay’s original agent left. Not everyone might be privy to such a privilege.
A little reading up and preparation can go a long way, should you decide to commit to such a plan.
About the Author
Donald is a practicing Certified Financial Planner in the financial advisory industry and has been speaking actively on the topic of personal wealth management. Some of the companies that he has spoken for include Great Eastern, 8I Education, and World Vision Singapore.
Donald is a top adviser from his company; a value investor and a certified estate planner. He takes a practical and simple approach towards planning. To date, he has underwritten easily more than $500 million worth of insurance coverage for individuals and companies.
And he still feels that is not enough.
Donald Lee Jianxing
Tel: 9125 5137
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