As the title above says, I feel that the next MiniBomb that will explode and perhaps even at a greater scale than the Lehman Brothers MiniBomb, HighNotes etc. This next time bomb will not explode within the next few years but perhaps 10 or 20 or 30 years later. This bomb will not be labeled “Mini” but it will be a MegaBomb. Don’t get me wrong, an ILP itself is merely a product and its suitability has to be match appropriately to the clients’ needs. However, similar to the MiniBomb fiasco, the ILP is significantly been mis-sold and its risks usually not disclose. Here are some reasons why I feel that ILP will be a time bomb:

1. The insurance cost – namely the mortality charges and morbidity charges – are in escalating fashion. The cost of insurance is based on a yearly renewable term. Moreover, the costs are not guaranteed. Due to such a structure, there is a high risk of the ILP not be able to sustain itself  on a long run. That is to say that policyholders may find themselves losing their entire insurance cover just because there is high cost of insurance at an older age;
2. As the ILP’s investment risks are fully born by policyholders, great care in management of the investment is required. As all ILPs invest in funds which are mostly active managed, close monitoring of the performance of such funds are required on a regular basis. Active managed funds are notorious for underperforming their respective market benchmarks. Many financial advisers who sold these ILPs do not understand the importance of helping their clients manage the investments on an on-going basis. As such, the investments are left alone for a long time. Should the investments underperform on a long-run, the risk of (1) happening increases significantly;
3. The asset allocation chosen for the client in the ILP is extremely important. It has been said that the returns of a portfolio is mostly due to the asset allocation chosen. I have seen many clients’ ILP whose asset allocation was randomly chosen by their advisers based on the “favour” of the month or year. For example, it is quite common to see ILPs containing single country fund like India and China if these ILPs were sold in the last few years. It is obvious that these ILP advisers are not trained in investments. They are mainly trained in selling insurance. Tt is possible that on a long-run, these portfolio may underperform and thus (1) happening is high.
4. Some clients like the product while others do not like. The key point is that all clients want to make an informed decision. An informed decision can only happen if all advantages and disadvantages are disclose in a manner that can be understood. If it cannot be understood, informed decision cannot be made. The clear disadvantage about ILP is the need to manage the investment risks because mismanagement of the investments will affect the insurance cover on a long-run. If the client feels that the investment risk is not acceptable, an alternative should be considered. If the client feels that the investment risk is acceptable due to its potential high return, the advisers must document this in writing in their KYC and disclose to their clients whether would the adviser help their client manage this portfolio on an on-going basis and the compensation fee structure. Discussion of the compensation structure to manage this investment should be brought up. The reason is because it is in the industry practice for investment adviser to be compensated to manage investment and secondly the ILP does not necessarily pay commissions beyond 3 or 6 years. Both parties must be honest with each other so that there will be no misunderstanding.

I am very sure many clients have not understood nor has been disclosed the risks in ILP mentioned above. I have seen many clients who asked me to review their policies. When I explain how an ILP works, it will almost be the case which they will tell me that their advisers did not disclose to them the investment risks and how it will affect their insurance cover on a long-run.

In the meantime, my advice to insurance advisers not to sell ILPs if they are either nor prepared to manage investment for their clients or they feel they are not competent to do so. They can always sell insurance that does not have the investment risks in an ILP.

This blog entry will be here as a historical archive to be revisited 20 years from now. In this manner, people will not say that I warned about RP-ILP based on hindsight.

(PS: There are many forms of regular premium ILP in the market now. Some RP-ILP has no insurance charges or insurance cover at all. These are pure investments. In the above paragraphs, I am referring to RP-ILP that provides high insurance cover for death and/or Critical Illness.)