Insurance: What to know about your investment-linked products beginning July 1

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on June 24, 2019 - June 30, 2019.

The main intention is for insurers and agents to be more prudent when selling a product to consumers. > O’Dell

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Come next month, the insurance premiums of policyholders of investment-linked products may be adjusted, says Mark O’Dell, CEO of the Life Insurance Association of Malaysia (LIAM), due to regulatory requirements that are set to be enforced from July 1.

The amount of premium paid could increase or remain status quo, depending on whether the coverage of the policy is enough to last until the end of the policy tenure.

“It is misleading to tell consumers that their premiums are definitely going to increase. [In fact] it might just stay the same, as long as the expected premiums that would be paid by a policyholder can sustain his or her [investment-linked] insurance policies until the end,” says O’Dell.

He says a policy document regarding investment-linked business was released by Bank Negara Malaysia in January to ensure that the rapid growth of the investment-linked business is supported by responsible industry practices.

According to the document, “at the point of sale, a licensed person must ensure that premiums/takaful contributions are priced at a level where an investment-linked policy/takaful certificate is expected to sustain its coverage until the end of its contractual term”.

If the amount of premium is insufficient, O’Dell believes insurers could offer a few solutions. One is a higher premium in return for the same sum assured and policy tenure. Or, if the premium is insufficient, policyholders can opt to pay the same amount with the option of having a shorter policy duration or a lower sum assured.

These are possible scenarios of how insurance companies will adjust to the new regulations, says O’Dell.

He adds that current policyholders of investment-linked insurance products who have taken a premium holiday, or recently increased their insurance coverage, may need to pay higher premiums as their insurance policies might become unsustainable.

He also emphasises that policyholders should understand their financial needs and review their insurance policies regularly to be aware of how much insurance coverage they need.

Before January, there were no guidelines that touch on the sustainability aspect of investment-linked products, says O’Dell. “Insurance companies have been working hard in the past six months to comply with the new guidelines.”

From July, new and current investment-linked policyholders will be given general information that explains how an investment-linked policy works and the concept of sustainability with regard to their policies. It will also tell policyholders the factors that could affect the sustainability of their policies and what actions they can take if their policies cannot sustain until the end.

From 2020, insurance companies will issue annual reports to policyholders telling them how long their policies can sustain given the amount of premiums they are paying.

“Again, the annual statement is just telling you how long your policy is expected to last. It does not change your premium. It is up to policyholders to choose whether to increase their premiums or adjust their coverage,” says O’Dell.

Investment-linked products that are sold after July 1 will automatically require consumers to pay the amount of premium expected to sustain their policies until the end of the contract term, he adds.


Changes in sales illustration and minimum allocation rate

The other two key initiatives introduced under Bank Negara’s policy document are changes to the sales illustration and minimum allocation rate of investment-linked products, says O’Dell.

Before July 1, the sales illustration of an investment-linked product will show consumers the potential returns of the investment fund (the fund tied to an investment-linked product). The returns depend on market conditions and the type of fund a policyholder opts for.

To break this down further, the current sales illustration shows consumers varying range of returns based on different types of funds. A fixed income fund could generate a potential return of 2% to 5%, an equity fund 4% to 9% and a balanced fund between 3% and 8%.

Based on these figures, an insurance agent would paint a picture to consumers of how the performance of these funds — at their peak and the lowest point — could affect their account value and premium contribution.

Starting next year, however, the policy document requires insurance companies to standardise returns for all funds to a more conservative estimate of 2% to 5%, regardless of the type.

O’Dell says this is designed to let consumers concentrate more on the protection features offered by a life insurance product instead of investment returns. “The main intention is for insurers and agents to be more prudent when selling a product to consumers. It could prevent customers from being distracted by the potential investment returns generated by investment funds and focus on protection,” he says, adding that the sales illustration does not affect the amount of premiums paid by a policyholder of an investment-linked product.

He says each insurance company would have its own best estimate on the potential returns each investment fund can generate within a specified period. These are determined by several factors, including the track record of the underlying fund, market performance and investment strategy.

“The insurance companies would make their best estimate and defend it to their board of directors and the regulator. They have to back their estimates with facts,” says O’Dell.

The return of investment funds based on these estimates determines the insurance premium consumers pay at the time of purchase, he says.

Bank Negara’s policy document also sets a minimum allocation rate (MAR) for insurers to follow.

O’Dell says the MAR requires insurers to invest a certain percentage of the insurance premiums paid by a policyholder in investment funds. The rest is used to pay for expenses such as agents’ commissions and marketing costs.

Based on the policy document, at least 60% of annual premiums will be invested in funds in the first three years of the insurance policy. The allocation rate will increase to 80% in the fourth to sixth year and 95% from the seventh to the tenth year. One hundred per cent of all premiums will be put to work in the market from the 11th year onwards.

According to materials published by LIAM, the allocated premiums would be used to purchase units of one or more investment funds. The cost of insurance and other charges will then be paid for by the cash derived from the sales of these units.

“The investment allocation rate will be increased [from July 1]. This is good for consumers. It is a protection measure for them to help them preserve the account value of their insurance policies,” he says.

O’Dell says this measure also goes hand-in-hand with Bank Negara’s plan to liberalise the insurance industry further. He says that from July 1, insurance companies will have more freedom to compensate their agents with different levels of commissions through the sale of investment-linked products.

“The increase in MAR would leave a limited amount of room for insurers to impose other charges [on consumers]. This will, in effect, limit the amount an insurer can pay for [agents] commissions and other expenses,” he says.

Will insurers increase premiums to compensate for the decrease in allocation for marketing and distribution expenses? O’Dell says this is unlikely. “It is doubtful that the cost for insurance within an investment-linked plan will go up (which would translate into higher premiums) as the market is competitive. The cost must also reflect the market rates.”


Investment-linked products experienced strong growth

O’Dell says consumers must be informed about the changes brought about by Bank Negara’s policy document. “The demand for investment-linked products has been on an upward trend in the past five years and the industry has grown significantly, overtaking the traditional life insurance business.”

As at 2018, there were more than 5.2 million investment-linked policies in force (policies that are still active) in the country compared with 3.8 million five years ago. This number represents about 40% of all insurance policies in force locally.

“These products are also the key contributors to the increasing penetration rate in the country,” says O’Dell.

Meanwhile, about 70% of medical and health insurance plans in the country are sold together with investment-linked products. In other words, many Malaysians and their families are protected by investment-linked products.

In comparison, O’Dell says the growth of the more traditional insurance products, such as whole life insurance, term life insurance and endowment products, have stagnated or declined.

He attributes the growth of investment-linked products to the flexibility and transparency these products offer. For instance, a policyholder can opt to pay a higher or lower amount of premium relative to the level of coverage desired.

Or, the policyholder can choose to contribute a higher premium for more protection if he wishes to do so later on in the tenure of the policy. If he is in need of cash, he can also withdraw some of the money he contributed to the policy. An investment-linked product also has a higher level of transparency compared with the more traditional [life plans], says O’Dell.

“In a traditional plan, you do not know what happens to the premiums you pay. You only know that you may have cash value after having paid for some time and you might get a bonus.

“In an investment-linked product, you have a monthly breakdown of everything that is in the policy, including any charges imposed. You can pick and choose the fund you want to invest in and track its returns. Yes, it may be a bit more complex, but it is more transparent,” he says.