IN TODAY'S fast-moving world of personal finance, it is common to see changes in the way financial institutions conduct business. For example, banks are selling unit trust funds and life insurance products these days.

Besides the broadening of the distribution channels, we also see much product innovation.

One such major product innovation offered by life insurance companies is the investment-linked product. This product, introduced four years ago, was offered alongside traditional life insurance products such as whole life, term and endowment products.

Why investment-linked?

Investment-linked products were introduced because of the dramatic growth in the unit trust industry. Investment-linked products, in many ways, are similar to unit trust funds except that it requires you to buy an insurance cover.

Investment-linked products were also created to address the "lack of transparency" issue associated with traditional life insurance products, by clearly distinguishing between the life protection and the savings/investment elements.

Also, administration, sales commission and mortality charges are made known.

This article seeks to provide some perspective on how investment-linked products compare to traditional products or unit trusts.

The difference

When you compare traditional insurance products with investment-linked products, you are comparing apples and oranges, so to speak. You are basically comparing traditional insurance products that are savings products with investment-linked products, which are investments where the buyer bears all the investment risks.

Generally, the returns from an investment can be better than those from savings, but then again, the risks assumed are also much higher.

When you buy a traditional insurance product with a savings plan, the life insurance company will declare reversionary bonuses or cash dividends every year; this will be added to the sum assured payable to the policyholder or his beneficiary.

Once declared annually, the reversionary bonus or cash dividends have to be honoured by the insurance company.

By and large, banks generate their income to pay interests on savings accounts or fixed deposits from lending the money out to borrowers who pay a higher interest rate than that received by the depositors.

In the case of life insurance companies, they generate the returns to pay reversionary bonuses or cash dividends by putting your money (premiums) into a portfolio of government and corporate bonds, properties, equities, loans, money market instruments and fixed deposits.

The maximum amount they can put into these asset categories is governed by the Insurance Act 1996 and Bank Negara guidelines.

Through this, and maintaining solvency margins, life insurance companies with certification from their actuaries, can safely declare reversionary bonuses or cash dividends annually.

The investment-linked product is very different. Instead, the money received is put into investment funds to buy equities or bonds after deducting administrative fees and allocation for insurance cover.

More importantly, by putting the money into the various equity or bond funds, the policyholder would benefit directly from any profits or income received, or suffer any losses incurred by them.

In summary, remember that buying a traditional product is about buying protection and savings, and buying an investment-linked product is about buying protection and investments.

So, looking at the risks of buying an investment-linked product, take due care and consideration before signing up for one.

John Ng draws from 19 years in the life insurance industry. This article is courtesy of Personal Money, The Edge's magazine on managing your finances.

Similarity with unit trusts

Sales of investment-linked products is predicated on the belief that in the long run, a portfolio of Kuala Lumpur Stock Exchange (KLSE)-listed shares will provide superior returns to the policyholders compared to a portfolio mix of equities, properties, bonds, loans and fixed deposits for traditional insurance products.

However, the reality is sometimes more complicated than that. The KLSE has not performed well in the last few years and, as a result, neither have the equity funds of insurance companies.

In fact, policyholders of traditional products would have done better than those who bought investment-linked products. To judge how investment-linked products will perform, it would be useful to look at the performance of unit trust funds that have a similar, if not better, cost structure.

Another point is that there is no "profit protection" for investment-linked products. So it is essential that you actively manage your investments. You need to be able to make judicious asset allocation decisions; otherwise you could risk having your gains swept away by cyclical trends in investments.

It also goes without saying that your choice of insurer will also depend on your assessment of its investment capability; get to know its investment track record as well as its investment team.