Oran Hall | Life Insurance as investment

QUESTION: I am a 23-year-old teacher with one-and-a-half years of teaching experience. I want to start investing and saving wisely, thus, I crave some advice. I just signed up for the Sagi-Gold Accumulator Plan, but there are many more ways to help myself to be set at a certain age in life. Is there any advice that you can provide me with?

- Samantha

FINANCIAL ADVISER: The Sagi-Gold Accumulator Plan is an equity-linked life insurance policy, which is structured to provide insurance protection with medium-term fund accumulation.

Equity-linked policies vary from company to company, but the policies offered by the same company also vary to meet the needs of different market segments.

Rather than examining the particular policy you have mentioned, I will look at some of the features of equity-linked insurance policies. Because they are insurance policies, policyholders are required to pay premiums monthly, quarterly, semi-annually or annually as the policyholder chooses.

The premium is used to pay for life insurance coverage to provide the death benefit. This is called the mortality charge or cost of insurance. The premium is also used to pay for administration charges, but a significant portion is invested in a segregated fund. This portion is usually a smaller part of the premium in the earlier years, one reason being that the commissions paid to the sales representatives or advisers come from the premiums. The portion invested increases significantly after those initial years.

The investment portion goes to an investment fund or portfolio or to several funds which tend to meet various investment objectives, such as capital growth, income, security of principal and currency hedge. Policyholders often have the option of selecting into which funds their money goes and in what proportion.

Generally, units in the segregated investment funds supporting these policies purchased with a portion of the basic premium are encashed or cancelled on a monthly basis to pay the cost of insurance.

Some policies provide for regular additional investment premiums, which are paid with the basic premium, but there may also be provisions for additional investment premiums payable on an ad hoc basis.

Because the value of the units in the segregated funds so described because they are set up to support a particular policy or group of policies and not commingled with the other funds of the insurance company is determined by the value of the securities which make up the portfolio, unit values fluctuate with the values of the investment instruments taken as a group.

Policyholders are generally able to surrender units linked to their policies, but there are usually limits and some conditions. In some cases, this course of action could affect the life insurance component on the policy.

Policyholders may choose the benefit payable on death. Two options are the total of the basic sum insured plus the cash value based on the bid price of the units, and the greater of the basic sum insured and the cash value. Different premium rates apply to each option.

Although there are cases in which units in certain funds cannot be cancelled by the policyholder, thereby ensuring that funds are always available to pay the basic premium and thus securing the death benefit, there are cases in which this is not so. Surrendering units may thus cause the fund value to decline to the point where funds are not available to pay for the insurance component. The usual consequence of this is that the policy will lapse. Of course, policies also lapse if contractual premiums are not paid.

Premiums tend to be higher the older the policy holder is. If the policy is a renewal term and many policyholders are often not aware of this as the mortality charge increases with age, it is critical that the value of the investment component is able to support the increase in that charge. The increase in the mortality charge tends not to be evident as the basic premium remains the same.

There are several expenses linked to the portfolios associated with equity-linked policies: expenses related to the buying and selling of securities, interest charges relating to money borrowed, valuation fees for real estate, and management fees, for example.

Some policies have a feature which provides for automatic inflation linking whereby the basic sum insured and the basic premium can be automatically increased within set limits to provide some inflation protection to policy holders and their beneficiaries.

An important benefit of equity-linked policies is the meaningful tax benefits derived from the investments associated with them.

What I have just described, in several ways, looks very much like investing in a unit trust or a mutual fund with some insurance. Equity-linked life insurance policies may have a place in an investment portfolio, but they are first and foremost insurance policies, so you may still invest in unit trusts and mutual funds if and when you have funds available.

If you clearly define what you want to achieve, budget and save, are prepared to be patient, make an honest assessment of the risks you can take, and become familiar with the various investment instruments and strategies, you can build an investment portfolio that includes stocks and even real estate over time.

- Oran A. Hall, principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel. finviser.jm@gmail.com