Effects of deductions Vs Cost of Distribution
When an insurance agent try to sell you a policy, he/she will have to show you the benefit illustration(BI). Both effect of deductions and cost of distribution figures should and must be found and accurately depicted in the BI.
Most agents do not wish to talk about effects of deductions as it will always paint a very bleak picture about the real cost of the insurance policy. Most agents prefer to illustrate about cost of distribution when questioned by their potential clients.
Cost of distribution covers:
- the total commission paid out for the policy to the agent and his agency for the next 5 years(depending on commission structure)
- the underwriting and administative fees to underwrite and prepare the policy
Effects of deductions covers:
- cost of distribution(as above)
- mortality charges and generally charges for your insurance coverage
- sales charge for ILP funds(for ILP only)
- annual management fees for ILP funds(For ILP only)
- any other fees payable on annual or monthly basis (For ILP only)
- also take into account the opportunity cost of the funds you could have grown if you leave it in an investment with the same growth minus the cost
You should now be able to realise that effect of deductions is an extremely important factor to look at when you are choosing between Investmet Linked Policies(ILP).
Some are against the use of effects of deductions as it also takes into account the opportunity cost of the fees paid and year-on-year appreciation. Some financial consultants are of the views that it makes the figures seems inflated.
My viewof the matter is that what you save on should be included as it will help you accumulate wealth. That is essentially what time value of money is about.
That being said, I would not advise comparing ILP with traditional policies as ILP will look unfairly expensive.
There is extra annual management fees and sales charge from the underlying funds but at the same time, there is much more upside potential in comparision. In deciding between a traditional and an ILP, one should not use effects of deductions or cost of distribution but instead look at the product features.
In short:
- If you are only looking at investment, go into shares directly or Unit Trusts if you do not have much funds.Senseless to go into ILP and let insurers earn the insurance coverage and be serviced by agent who are better in insurance than investment.
However, if I am buying an insurance for my retirement and protection, I would choose an ILP over a traditional plan.
- Flexibility to withdraw from cash value if need to
- If we look at a time frame of 20 years for any period, the stock market will definitely perform better than 3-4% of a traditional policy.
So personally, I would
-use term insurance to cover my protection needs until I am 65 or when my dependents become financially independent
- ILP for disciplined savings and to grow money for my retirement needs more than 20 years later. For the last 5-10 years, I will switch to less aggressive funds and at least 50% in bonds and fixed income.
A final word of caution: Some insurers charge zero sales charge but significantly higher anuual management fees than market to distract and confuse consumers. However if you are looking at effects of deductions, all are taken into consideration and you can compare costs effectively and accurately
