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TH.': MALAYSIAN INSURANCE INSTITUTE


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Fadzela LatifBBA (Hens) Multimedia Marketing (MMln1131. 11th Floor Block ADamansara Intan. e-Business Park. Jln SS 20/27.47400 Pelal ing Jaya. Selanger.HIP: 013-3683006L is-O-OOO:L.

Copyright The Malaysian Insurance Institute 1998

All rights reserved. Materials published in this study course is copyrightand may not be reproduced in whole or in part including photocopying orrecording, for any purpose without the written permission of TheMalaysian Insurance Institute. Such written permission must also beobtained before any part of this publication is stored in a retrievalsystem of any nature.

First published by The Malaysian Insurance Institute 1998

This is to record THE MALAYSIAN INSURANCE INSTITUTE's note ofthanks to the following individuals for their contributions to theInstitute pertaining to this text:

Encik Azman IsmailMr Bose Dasan K P

BSc (Hons) (Mathematics and OperationalResearch)BEcons (Hons), MBA (Cranfield),ChFC (The American College)

BA (Actuarial Studies & Statistics). BA (Actuarial Science)BSc (Business Administration), MBABSc (Actuarial Science)FCIl (UK), FMIl, FAIl (Austr)

Mr Khor Hock SengMr Moi Seng YewMr .Soo Leng TheongMr Tan Chai PohMadam Tan Lee Hoon

Published by The Malaysian Insurance Institute (35445H)No.5, Jalan Sri Seman tan 1,Damansara Heights

50490Kuala Lumpur


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CERTIFICATE EXAMINATIONIN INVESTMENTLINKED LIFE INSURANCE

1st Edition 19982nd Edition 19993rd Edition 19994th Edition 20005th Edition 2002

Study Course

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PREFACE

This coursecontains the studymaterials forthe Certificate Examinationin Investment-linked Life Insurance. The objective of this basicexamination programme is to provide a fundamental knowledge ofinvestment-linked life insurance to persons who intend to marketinvestment-linked life insurance policies, in order that they attain aminimumleveloftechnical competency.

This coursea. introduces the nature of investment-linked life insurance;b. provides a fundamental knowledgeofthe technical, taxation and

other aspects of investment-linked lifeinsurance, including anappropriate understanding ofinvestment-linked life insuranceproducts selling;

c. instills a sense of socialand professional responsibility in thosesellinginvestment-linked life insurance products;

d. .creates an awareness of the roleplayedby insurance in theeconomyand the significanceofthe socialfunction of theinsurance and the roleof the agents inbringing about theseobjectives.

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CONTENTS

._

STRUCTURE OF INVESTMENTLINKED FUNDS

6.1 Introduction 6/16.2 Accumulation Units 6/16.3 Distribution Units 6/16.4 Types of Investment-linked Funds 6/26.5 Risk-Return Profile 6/36.6 Switching 6/3

HOW INVESTMENTLINKED LIFE INSURANCEPRODUCTS WORK

7.1 Introduction 7/17.2 The Working of Investment-linked Life Insurance 7/17.3 Top-ups 7/47.4 _ Single Premium Policies - Methods of

Calculating Benefits 7/47.5 Withdrawal Benefit : 7177.6 Surrender Value 7/77.7 Death Benefit '" 7/77.8 Regular Premium Policies 7/8

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CONTENTS

BENEFITS AND RISKS OF INVESTING IN INVESTMENT-LINKED FUNDS

8.1 Benefits 8/18.2 Risksof Investing in Investment-linked Funds 8/2

COMPARISON BETWEEN INVESTMENT-LINKED LIFEINSURANCE AND TRADITIONAL WITH-PROFIT LIFEINSURANCE PRODUCTS

9.1 Introduction 9/19.2 Traditional Guaranteed Without-profitLife

Insurance Products 9/19.3 TraditionalWith-profitLifeInsurance Products 9/29:4 Investment-linked LifeInsurance Products 9/49.5 Other Comparison- Transparency 9/6

TAXATION AND LAW COVERING INVESTMENT-LINKEDLIFE INSURANCE PRODUCTS

10.1 Introduction lOll10.2 TaxationofInvestment-linkedLifeInsurance lOll10.3 LawCoveringInvestment-linkedLifeInsurance 10/310.4 Other LegalRequirements 10/7

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CONTENTS

IDENTIFYING AND SATISFYING CUSTOMERS' NEEDS

11.1 Introduction 11/111.2 Conducting the Fact-Find 111111.3 Assessing and Satisfying Customer's Needs 11/211.4 Making Recommendations to the Customer 1112

MARKETING AND AFTERSALES SERVICES, ETHICSAND CODE OF CONDUCT

12.1 Introduction 12/112.2 Marketing ; 121112.3 Ethics and Conduct 12/6

GLOSSARY

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---------1---------INTRODUCTION TO INVESTMENT-LINKED LIFE

INSURANCE

' ".. Introduction INTRODUCTIONInvestment-linked insurance offers investorspolicies where values are directly linked toinvestment performance. The policyowner'spremiums are used topurchase fundsinoneofthe insurance company's investment funds.The value of the policyis linked to units in aspecialunitised fund run bythe lifeofficeortothe units of an authorised unit trust. Thevalues of the units directly reflect the valuesof the underlying fund, and fluctuateaccording to the performance of theseinvestments. The benefits are thereforeexpressedin investment at their market valueat the time the benefits are paid.The investment fund canhave a widerange ofinvestment modescoveringreal estate, equityor stock, fixed interest, money, etc. Theseinvestment funds can either be 'external unittrusts' (or mutual funds in the USA) or an'internal unitized investment-linked fund'.Aninternal unitised investment-linked fund ispart of the life insurance fund of a lifeinsurance company. In other words,policyownerare offereda range ofunit-linkedfunds in whichthey can invest.For the purpose of our study, the term"Investment-linked" shall be similar to theterm "Unit-linked" in the United Kingdomand to the term "Variable Life" in theUnited States.

1 1 1


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---------2---------KEY CONSIDERATIONS IN INVESTMENT

IPDI IntroductionID Investment Objectivesl1li FundsAvailable.. Risk orSecurity?l11li Investment Horizon.. AccessibilityofFunds.. TaxationTreatment. . . Performanceofthe Investment.. Diversification

INTRODUCTION

There is an increasing need for soundinvestment advice to be available. This isespecially true in Malaysia where investors,manyofwhomare small time investors, basedtheir decisions on little research.In order for the public to be able to make asound judgement on investment, it isimportant that the key fundamentals andconsiderations in investment be understood.The following are some fundamentals andconsiderations that feature prominently: .

Investment Objectives Funds Available Risk or Security Investment Horizon AccessibilityofFunds TaxationTreatment Performance ofthe Investment Diversification

2.2 INVESTMENT OBJECTIVESPeoplegenerally invest their moneytoprovidea. a comfortable standard ofliving;h. funds for their dependants;

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funds for the education and up-bringingof their children;

d. an improvement in their financialc.

position;e. income in retirement;f. funds for paying necessary expenses and

taxes when the person dies.Depending on the investment objectives, aperson would need to choose betweeninvesting in assets that yield more regularincome or in those that have better potentialfor capital gain. Different types ofinvestmentsproduce different combinations of regularincome flow and capital gains.

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Fixed deposits for example produce onlyregular income flowwithout capital gains. Onthe other hand, investments in commoditiesproduce no regular income flow but offer thepossibility of capital gains.

2.3 FUNDS AVAILABLEThe level or amount of funds. availabledefinitely affects the investment decision. Ifan investor has a small amount of free funds,certain types of investment are not accessibleto the investor. The more funds an investor)las!. the gr~ater or wider ~s the choice ofinvestment available to the investor.

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Another consideration pertaining to funds isthe source of the available funds, whether thefree or available fui;d~-;;~-provided out ofincome. If the potential investor can set asidea fixed amount of current income which issurplus to his needs, then certain investmentslike insurance policies, unit trusts and the likecan be considered.

2.4 RISK OR SECURITY?Another important consideration ininvestment is the individual's need forsecurity and his attitude towards risk.Risk can be classified into two particularcategories in relation to investment. Firstly,the risk of losing some or all of a person'sinitial investment, and secondly, the risk ofthe rate of return on the investment notmatching up to one's expectation.There is a wide range of 'risk profiles'among individual. People with much wealthcan afford risks that would cripple smallerinvestors. Moreover, different individuals willhave different attitudes to risk, and differentlevels of willingness to accept it.Some people by nature tend to be heavy risktakers and may make investment decisions onimpulse.Others tend to be very cautious and will onlymake a decision after careful research, studyand consideration ofthe exposures involved.Majority ofthe population, however, tend to bein between these two extremes.In addition to the attitude of an individual,the type of investment itself has certaininherent risks. Investments that offer thegreatest opportunities for capital and incomegrowth generally carry the highest risks anduncertainties. While investments that offerlow and slow growth in capital and incomegenerally carry lower risks.Evaluating risk, unfortunately, is a verycomplex process. But investors should try to

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factor the risks and returns of different assetclasses in making investment decisions.

2.5 INVESTMENTHORIZONA person's investment horizon will greatlydepend on the investment objectives, age ofthe investor and the current financial

'-condition of the investor. The time horizon canrange from a few days (more speculation thaninvestment) to several years.A match between the investment horizon andthe maturity of an investment asset is veryimportant, otherwise a safe investment canturn into a risky one. For example, a depositorwho keeps his money in a top-tier bank isconsidered to be taking one of the safestinvestments. However, if the investmenthorizon is say, fifteen years, the choice ofinvesting in a bank deposit becomes a riskyone as the depositor will encounterreinvestment risk from rolling his bankdeposits and the risk of inflation eroding thereal value of the original sum ofmoney.

2.6 ACCESSmILITY OF'FQNDS'With regard to the use of funds, accessibility offunds has three components.First, if an individual requires the fund in a.lIhQ_rt_p.~ri~df time, he would not want to lockthe fund in an investment that goes beyondthe time frame that the fund is needed.The second element is. the cost or penlill;.y_ofrealising the investment before its maturityperiod should the fund be needed urgently.

The third element is the initial cost in settingup or buying into the investment.

2.7 TAXATIONTREATMENTDifferent types of investment vehicles enjoys(or suffer) a wide range of tax treatment, bothas regard the taxation of the investmentvehicle itself and the subsequent taxationliability of the investor. An individual should,therefore, consider the different tax treatmenton different types of investments beforemaking a decision on what to invest.There is no special tax laws relatingspecifically to investment-linked lifeinsurance products. The tax status ofinvestment-linked life insurance products isthe same as that governing traditional with-profit life insurance products. Read Chapter10 for more details on taxation.

2.8 PERFORMANCE OF THEINVESTMENT

The performance of an investment depends ona country's economic factors, the competenciesand capability of the management team andthe ....invested company's level. of costs.Performance also depends on the pastexperience and history of the investedcompany although other factors like the lifecycle of the investment must also be takeninto consideration.

.-;.,.

2.9 DIVERSIFICATIONDiversification in investment is~_l::lerocess ofinvesting acres different asset classes and

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across different market environments.Diversification is a strategy used byprofessional fund managers that has proven'effective in reducing risk without sacrificingreturns, Investors should also try to invest ina range of investment vehicles.The proverb of 'never putting all one's eggs inone basket' applies very appropriately toinvestment. Diversification can substantiallyreduce risk with small reductions in return. It

involves the spreading of risks by putting themoney under management into severalcategories of investments such as shares,bonds, money market instruments, etc.Diversification can also be achieved by buyingshares in different countries and by choosingdifferent types of shares.Chapter 3 described the vanous choices ofinvestments available to investors.

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ri.---------3---------TYPES OF INVESTMENT ASSETS

- InvestmentChoices.. Cash and Deposits- Fixed IncomeSecurities. . . Shares. . . . . Unit Trusts.. Investment Trusts Properties-Derivatives.. Commoditiesam LifeInsurance. . . . Annuities

a'INVESTMENT CHOICESIn this chapter, we will look at the range ofinvestment choices available to individualinvestors. The commoninstruments availableinclude: Cash and Deposits Fixed IncomeSecurities Shares Unit Trusts Investment Trusts Properties Derivatives Commodities Life Insurance Annuities

CASH AND DEPOSITS

The term cash and deposits refers toall liquidinstruments that carry little or no risk thatthe principal amoun'i;invested can'be lost.Strictly speaking however, cash cannot ber~garded as an investmeI?-t. Cash is,ultimately, used as a means only to financeinvestment. The capital value of cash will not

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increase and will not generate any additionalincome.Ithas no value in itself.It is ofvalueonlyas a mediumofexchange.For the purpose of our learning however, thedefinitionofcashwill include short-term debtinstruments. Thesecover:-(a) Treasury bills(b) Bank accounts

3.2.1 TREASURYBILLSThe Malaysian Government is involved tosome degree in the financing of publicutilities. Normallyfinancingofpublic utilities~re funded. through ta~es. However, totalgovernment expenditure cannot be fullyfunded in this way and someborrowing on ashort-termbasis is needed.One of the methods of borrowing from thepublic is through the issuance of TreasuryBills, These are short-term governmentfundingvehiclesissuedona regular basiswithrepayment normally within a year. They areissued by the Central Bank to the discountmarket.Theya~ethe safest typeofinvestmentsand are generally considered to be of no riskexceptifthe countryis politicallyunstable.

3.2.2 BANKACCOUNTS

t These are time or fixed deposits placed withbanks for fixed periods with fixed interestrates for that period.Generally,the longerthedeposit period, the higher will be the interestrate. Some of the accounts available are.Savings Accounts, Current Accounts, FixedDeposits,Investment Accounts,Time Deposits

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and OffshoreAccounts.The factors that may influence 'the choice ofdeposits are:- funds available for investment how long the funds can remain in the

account whether emergency withdrawals are

likely prevailing market conditionsAs all banks in Malaysia are licensed andregulated by the Central Bank, there is verylittle.risk of loss ofprincipal and interest. TheMalaysian government has time and againassured depositors that their money is safewith the banks.However,because oftheir low-risknature, the~isadvantage with bank deposits is that theyare lowyielding in return.Also, time deposits do not provide a goodinflation hedge, as the stated interest ratesoffered by banks at the inception do notchange over the deposit period in response tochanges in the market interest rates.Another disadvantage with, time deposits isthat there are penalties upon' early or_preDl:aturewithdrawal, such as the loss ofinterest.

FIXED INCOME SECURITIES

Fixed income securities are a group ofinvestment vehicles that offera fixedperiodic

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return. A fixed income security is a security orcertificate showing that the investor has lentmoney to the issuer, usually a company or agovernment, in return for fixed interestincome and repayment of principal atmaturity. Fixed income securities can beregarded as lOVs issued by companies orgovernment to raise funds.Fixed income securities generally stresscurrent income and offer little or noopportunity for appreciation in value. Ifthere is an active secondary market, they canbe bought and sold at anytime beforematurity. This marketability gives theinvestors the opportunity to realise capitalgains since fixed income securities prices mayrise if interest rate fall. However, if thesecondary market is inactive, the investors'money is locked up for the full life span of thesecurity.

The types of fixed income securities includea. Money Market Instruments (discussed

under 3.2 on Cash and Deposits)b. Government Bondsc. Corporate Bondsd. Preference Shares (discussed under 3.4

on Shares)

3.3.1 GOVERNMENTBONDSGovernment bonds are effectively financialinstruments used by the government toborrow money from the public. Governmentbonds are the safest types of investments,carrying almostno default or credit risk sincethe government guarantees interest paymentsand repayment of the principal. The term and

interest rate of government bonds are fixedand usually issued in multiples of RM1,OOO.The investor gets the interest-and his capitalback on maturity.Government bonds can be classified accordingto the maturity period as follows:- short term bonds, usually less than five

medium term bonds, usually five to tenyears to maturitylong term bonds, usually more thanfifteen years to maturity

Government bonds are i~~l.!!Hlrom ~imetotime by the government when it wants to raisemoney to finance projects.

3.3.1.1 Advantages and DisadvantagesSince government bonds are backed bythe government, they are considered verysafe. They are very marketable and incomefor future years are guaranteed. However,in times of high inflation, capital can beeroded.

3.3.2 CORPORATEBONDSLike the government, companies can alsoissue bonds or loan stocks. There are basicallythree types of corporate stocks. They are Debenture stocks Loan stocks Convertible stocks

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3.3.2.1 Debenture stocks

These are effectively secured loans to acompany.The security is either a fixed chargeon the company's property or some of itsassets such as trading stock. If the companydefaults on the loan, the investor can takeover and sell the property charged to get hismoney back.~~~~~s are appointed on the issue of stocksto supervise the way the company performs itsobligations concerning the payment ofinterestand capital. In the event of default, thetrustees act for_t~einvestors.Like government bonds, debenture stocks paya fixed interest rate for a fixed term at th~ endof which the capital is repaid. -However, the company can repay earlier if itwishes. Corporate stocks are not as secure asgovernment bonds as the government does notguarantee them. A company can becomeinsolvent and be unable to pay the interestdue. Hopefully the charge on property wouldmean that this could be sold to repay thecapital, but a forced sale might not raiseenough money to cover the capital.Interest rates for corporate bonds tend to behigher than government bonds as' the 'securityis lower. . .. . .....

3.3.2.2 Loan stocks

These are unsecured loans to a company. Boththe interest rate and the term are fixed.If the company defaults, the investor has nosecurity and thus is in the same position as all

the other unsecured creditors of the company.The investor mayor may not get back hiscapital depending on the company'sperformance. Compared to debentures, loanstocks are much less secure. They therefore,normally carry a higher interest rate.

3.3.2.3 Convertible stocks

The difference between convertible stocks andthe above two stocks (i.e, debentures and loanstocks) are that it can be converted to ordinaryshares of a company on a fixed date.On that date therefore, the investor canconvert his investment from a fixed interestloan to being a part owner and entitled to ashare of its profits through dividendsdeclared. The decision to convert depends onwhether dividend income and capitalappreciation in share price are better than thefixed interest given.

3.3.2.4 Advantages and Disadvantages

In general, corporate bonds tend to give ahigher return than governmerit bonds.For some investors, they are also moremarketable and can be sold for capital gains.However, they are more risky thangovernment bonds.

SHARES

Shares are different from stock in that ashareholder is a part owner of the company. Acompany is a separate legal person, which is

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------------------~Q]~------------------TYPES OF INVESTMENT ASSETS

owned by all of its shareholders. Theshareholders control the company through thefact that basically each share carries one voteat company meetings. The shareholders canthus decide on major issues and vote in newdirectors to run the company if they wish.Shareholders are not liable for the debts oftheir company.Each company maintains a register ofshareholders and each shareholder gets ashare certificate as evidence of title.Companies can be public or private. Generallyspeaking, private company shares are notlisted on the Stock Exchange and are notavailable to ordinary investors. Public limitedcompany shares can be quoted on the StockExchange if they meet the Exchange'srequirements.The workings of the Stock Exchange (such asthe KLSE) are regulated by its Council toprotect the investing public. The shares of allmajor public companies are traded on theStock Exchange, which means that there is adaily list of their prices, which appears in thenewspapers.Listed company shares are thus easy to buyand sell through stockbrokers. The shares canin theory be bought and sold on any workingday, although on a new issue of shares in apopular company (for instance a privatisation)there may be more would-be buyers' thanshares available. Equally, if a company is inbad trouble there may be no buyers at all.The value of a share fluctuates according tothe market's view of the worth of the company.If a company is doing well, its share price willtend to rise and if it is doing badly it will tendto fall.

Share prices however, are also influenced byother factors, such as how the country'seconomy is doing overall, the general level ofinterest rates, inflation rate, companyearnings and currency performance.A share can thus, be a volatile investment. Ashareholder must therefore realise that hecould lose all his money in the invested share.In theory the chances of this happening shouldbe reduced by investing in shares of large, wellestablished, reputable companies, but eventslike the one happening in mid-1998 has shownthat this does not always work in practice.-he costs of buying and selling shares includestockbroker's commission as well as thedifference between buying prices andselling prices.

3.4.1 ORDINARYSHARESThe holder of an ordinary share in a companyis a part owner of the company and is entitledto share in its profits in the form of adividends. Dividends are paid. out of thecompany's profits as decided by the directors.There is no certainty that a company will makeprofits and thus no certainty that there will bea dividend. However, a company's track recordcan be inspected to judge whether profits arelikely to be made and dividends paid.Dividends are usually paid bi-annually, andprovide income from the investment.An investor will also hope to make a capitalgain from the shares by an increase in theshare price, although this is in no wayguaranteed. The price of a listed share willfluctuate from day to day according to the

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company's progress and general economicconditions. Announcements of high profits anddividends will tend to increase the price. Lowprofits have the opposite effect.A shareholder can always realise hisinvestment by selling the shares. This may beeasy for a successful, listed company butimpossible for an unsuccessful, unlistedcompany. Shares are thus a risky investment.An investor could lose all his money,particularly if he only invests in onecompany's shares. A portfolio of shares indifferent companies is thus more advisablethan having all one's eggs in one basket.Dividends on shares are paid net of basicrate tax.

3.4.2 PREFERENCE SHARESThese are shares which give the holder a rightto a fixed dividend provided enough profit hasbeen made. This right takes precedence overthe right of ordinary shareholders todividends. Preference shares differ fromstocks in that although the income is fixed itis not interest and may not be paid if profitsare not made.Preference shares differ from ordinary sharesin that the@ividend),m never be mQre thanthe fixed rate even if profits are more than

~T _ -~ - ~enough to cover it. They are therefore, slightlymore secure than ordinary jsharea, but less _profitable.

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3.4.3 ADVANTAGES ANDDISADVANTAGES

By investing in shares, the investorsparticipate directly in the future of the

company. Shares also provide good dividendsand capital appreciation. They are also veryliquid as shares can be traded in the openmarket. However, as mentioned before, sharescan be very risky as the value can go below theprice that the shares were bought for.

UNIT TRUSTS

Unit trusts are useful vehicles for smallprivate investors, who do not have sufficient-__~+.-~.-.......-....__+ ~funds and/or time, to receive the benefit ofprofessional investment management as wellas access to a diversified range and spread ofinvestments which is not readily available tothem individually. The investment in unittrusts could generate income in the form ofdividends, interest and capital gains.In Malaysia, unit trusts are authorised andsupervised by the Securities Commission .A unit trust is a pool of funds contributed bymany investors kept in trust by a trustee(usually a bank) and managed by -a 'professional fund manager.A unit trust is established by a trust deed.This deed enables a trustee to hold the pool ofmoney and assets in trust on behalf of theinvestors. Another party, the investmentmanager (also called fund manager), managesthe pool. The fund manager manages theportfolio of investments and operates themarket for the investments (i.e. administersthe buying and selling of shares in the unittrust itself), The unit trust is essentially athree-way arrang~--;mong investors, thetrustee and the fund manager.--3/6

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19/90

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The investments of the unit trusts areselected and managed by the fund managersbut are legally owned and held by the trusteefor the benefit of the investors (who are theunit-holders). The trustee must ensure thatthe fund managers adhere to the provisions ofthe trust deeds and act generally to protectthe unit-holders.The trust deed sets out the fund manager's investment powers; the price structure; the registration of unit-holders; the remuneration of the fund

managers; the accounting and auditing rules.Investors buys units in the unit trust at theoffer price calculated as per the trust deed.Units can be sold back at any time at thebid price.It is not necessary to use a stockbroker andsales call can bemade without the need to finda purchaser as would be i~ the case of shares.The fund managers -can create as many newunits as investors require and can cancel unitsif new purchases are exceeded byencashments, i.e. the amount of cash that theunits can be converted into.Unit trusts, however, have no fixedredemption date. The trusts are open-endedfunds and, if too many investors cashtheir units, the trusts have to sell the fund'sassets.Unit trusts investment fluctuate in line withstock market prices and involve up-frontcharges. Unit trusts should not be seen as

very short-term investments of less than say,three years.Investors can choose from a wide variety ofunit trusts with different investmentobjectives. A trust may aim for high income ora high capital growth, or a combination. Sometrusts invest in specific countries or regions.It is important that the types of unit trustschosen match the investment objectives of theinvestor. All unit trusts are required to clearlystate their investment objectives on theirprospectus. Every investors should acquirethis prospectus before buying into the trust.The types of assets that may be bought by thefund manager are also specified in theobjectives of the trust contained in thetrust deed.Examples of unit trusts include those byAmanah Saham National,' Kuala LumpurMutual Fund and. Mayban ManagementBhd.

3.5.1 ADVANTAGES ANDDISADVANTAGESThe advantage in unit trusts is the spread ofinvestments open to unit-holders. In addition,unit trusts have lower risks when compared toshares. Furthermore, professional investmentservice is provided by the fund managers andthis minimises paper works to the' investingunit-holders. Income from dividend can alsobe reinvested.The disadvantage in unit trusts includes thebewildering array of funds and the extra costsor charges which must be paid for switchingfrom one fund to another.

3 17

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20/90

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i'lINVESTMENT TRUSTS

The function of investment trusts is similar tothat of unit trusts, i.e. to make investmentmuch simpler, more accessible and more costeffective for small investors.It is important, however, to recognise that aninvestment trust is a company registeredunder the Companies Act. An investor istherefore purchasing shares in that company.The company itself will invest in (usually) awide range of equities and other investments.With a unit trust, however, the investor buysunits in the trust itself and not shares inthe company.Investment trusts, like unit trusts, both poolcontributions from their investors, and thetotal fund is then managed by specialist fundmanagers, whose function is to buy and sellshares (i.e. manage the investment) of thetrust tomake investment profits.These profits increase the value of the fundand, therefore, the value of each investor'sshare of the fund increases. Ifthe trusts sufferlosses then the investor's share will bereduced in value and the price of his unitswill fall.The unit prices are recalculated every dayand quoted daily. in at least one nationalBahasa Malaysia newspaper and one nationalEnglish language newspaper. The pricereflects the value of the underlyinginvestments.If the unit trust has 10million units and theInvestments could be sold for RM20 million,

then the bid price will be RM20 per unit.There is a spread, generally around 5%between the bid and offer prices, whichis effectively a form of charge. There is alsoan annual management fee deducted bythe fund managers from the income ofthe trust.Investment trusts are closed-end funds anddo not have to dispose of assets if largenumbers of investors sell their shares. Likeunit trusts, however, investments trustsinvestments fluctuate in line with stockmarket prices. Up-front charges are involvedwhich are usually lower than that forunit trusts.Investment trusts also should not be seenas very short term investments of less than ,say, three years. Investment trust, generally,have a higher risk/reward profile thanunit trusts.An example of an investment trust is thelisted Seacorp Schroders.

3.6.1 ADVANTAGES ANDDISADVANTAGESThese are similar to unit trusts mentionedabove, except that investment trusts aremore flexible as investors can borrow tofinance their purchases of the investmenttrusts. This can be very beneficial to theinvestment trusts holders. However, with theflexibility to borrow fund to purchase theinvestment trusts also mean that theinvestors are open to greater risk exposuresif the price of investment suddenly goesdown.

3/8

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21/90

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ROPERTIESReal estates have always been part of theinvestment scene. There are basically threetypes of real estate investments. These areagricultural property, domestic property andcommercial/industrial property both locallyand overseas.

The price of an agricultural property dependson the following factors:a. quality ofland as reflected on the quality

and profitability of the crops it grows,b. the location of the land,c. the value of the buildings on the land.On the other hand, the price of domestic andcommerciaVindustrial properties generallydepends on the location and types ofbuildingson the land.

3.7.1 ADVANTAGES ANDDISADVANTAGESProperties can provide good capitalappreciation and a steady flowof income.Theyare therefore considered low risk investmentespecially good repayment methods areobtained. By mortgaging the property capitalcan also be free. However, during economicrecession property could be difficult to bedisposed off.

DERIVATIVES

Instead of buying a security outright, aninvestor can buy a derivative of the securityinstead. Derivatives are financial instrumentswhose values are linked to the price ofunderlying instruments in the cash markets.For example, a stock index future is linked tothe performance of a specified stock market.Stock options and financial futures are twopopular derivative instruments for investors.

3.S.1 OPTIONSRather than trading directly in a security,investors can buy a right, not an obligation, topurchase or sell the security at a future date.This is called an option. Options need not beexercised, and often will not be worthexercising.A share option is a financial instrument thatgives the investor the right to buy or sell agiven number of shares of the underlyingstock at a fixed price within a specified.time period.The life of an option may vary but the commonduration adopted is three, six and ninemonths. Over-the-counter options can also bebought by institutions forlonger periods, fromone to five years.A call option gives the holder of the option theright to buy (or 'call away') say 100 shares of aparticular stock at a specified price, orpremium, any time prior to the specifiedexpiration date.

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A put option gives the holder of the option theright to sell (or 'put away') say 100 shares of aparticular stock at a specified price prior to aspecified expiration date.Investors purchasing call options will behoping that the share price will rise so thatwhen the option is exercised, the premiumplus the fixed price will be less than thevalues of the shares. Call options, thereforepermit investors to speculate on a rise in theprice of the underlying shares without buyingthe shares itself.Investors purchase put options if they expectthe share price to fall, because the value of theput options will rise as the share pricedeclines. Put options allow investors tospeculate on a decline in the share pricewithout selling the shares short.Sellers of either of these options will want thereverse to happen so the options will not beexercised and they will profit by the amount ofthe premiums.

3.8.1.1 Advantages and DisadvantagesBy investing in options, the investor has 'thepotential to boost profits from share pricemovements.nle

De However,investing in options is also risky as anm investor must be prepared to lose all his money.

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period, a stated number of shares of theunderlying stock at a specified price. Put andcall options are created by investors (whetherindividual or institutional).Warrants, also known as transferablesubscription rights (TSR), gives the holder theoption to subscribe the shares in the company at a pre-determined ratio (conversion

ratio); at a pre-determined subscription price

(exercise price); and within a specified time period. The life

span of a warrant is fixed at thebeginning and cannot be varied.

Warrants typically have maturities of at leastseveral years, and their terms are notstandardised. Each warrant is unique.Warrants are seldom issued on their own, butare often issued free and attached to rights orloan stocks as an added attraction orsweetener allowing the corporate issuer toobtain a lower interest rate (i.e. financingcost). Warrants can be detached from the loanstock and sold' separately in the securities'market. The options attached to the warrantscan be exercised by subscribing for ordinaryshares in cash, by exchanging the loan stockor by a combination of both.

3.8.2.1 Advantages and DisadvantagesPurchasing warrants is one benefit toinvestors without a large initial outlay toestablished an exposure to shares. Theinvestor will buy the warrant, pay the exerciseprice at a later date and convert the warrantto the underlying share.

3.8.2 WARRANTS (TRANSFERABLESUBSCRIPTION RIGHTS [TSR])Warrants are very similar to that of the calloptions. A warrant is a corporate-createdoption to purchase, within a specified time

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23/90

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By selling the warrants given to him in thefirst instance, an investor can benefit from thecapital gain. When the price of the underlyingshare goes up, the investor may profit byselling the warrant or exercise it to getthe stock.The disadvantage of warrants is that onexpiry, warrants which are not exercised losetheir value completely. Unlike ordinaryshares, there is no chance for price recovery.Once the warrant has expired it is worthless.In addition, holders of warrant do not receiveany income in the form of interest ordividends. They also carry no votingprivileges.

3.8.3 FUTORESPhysical commodities and financial 'instruments typically 'are traded in cashmarkets. A 'cash contract calls for immediatedelivery and is used by those who need acommodity now. Cash contracts cannot becanceled unless both parties agree. Thecurrent cash prices of commodities andfinancial instruments can be found daily insuch sources as the business pages of thenational newspapers.There are two types of cash markets" spotmarkets and forward markets. Spot marketsare markets for immediate delivery. The spotprice refers to the current market price of anitem available for immediate delivery.Forward markets are markets for deferreddelivery. The forward price is the price of anitem for deferred delivery.Forward contracts are centuries old, traceableto at least the ancient Romans and Greeks.Organised future markets, on the other hand,

only go back to the 1860s, with financialfutures being relatively new, dating fromthe introduction of foreign currency futuresin 1972.Future markets are, in effect, organised andstandardised forward markets. An organisedfutures exchange standardised thenonstandard forward contracts, establishingsuch features as contract size, delivery dates,and condition of the items that can bedelivered. Only the price and number ofcontracts are left for the future traders tonegotiate. Individuals can trade withoutpersonal contact with each other because ofthe centralised market place. Performance isguaranteed by a clearinghouse, relieving oneparty to the transaction from worry that theother party will fail tohonour its commitment.A futures contract between two parties (thebuyer and the seller) thus set a price today foran instrument that will be delivered on aspecified future date. Stock index future arefutures contracts based on a particular shareprice index constructed tomeasure the overallprice movement of a stock market.The trading of index futures involvedstandardised contracts to buy or sell ahypothetical portfolio of all stocks included inthe index at some specified future date at aprice agreed at the time of the deal.The buyers agree to take delivery and to makecash payment at expiry date, and the sellersagree to make delivery at the same time. Thesettlement of the contracts is made in cashwithout the actual delivery of the securitiescovered by the index. The profit derived from ~Ftrading stock index futures is determined by ,comparing the original contract value with the I ~ , " .contract value at the time of settlement.

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3.8.3.1 Advantages and DisadvantagesThe futures market serve a valuable economicpurpose by enable investors to protect theirinvestment (or hedging) by taking positions inthe futures market to protect the gains theyhave made in the cash market. The risk ofprice fluctuations is shifted from participantsunwilling to assume such risk to thosewho are.

Another economic function performed byfutures markets is price discovery. Becausethe price of a futures contract reflects currentexpectations about values at some future date,transactors can establish current pricesagainst later transactions.An investor may also wish to engaged inspeculative trading and takes on pricefluctuation risks in order to have a chance at. making large gains. However, a clearunderstanding of the concept of hedging(which can be briefly described as assuming offutures positions opposite to cash positions inan attempt to minimise the risk of financialloss from adverse price changes) and theamount of gain or loss that could result fromany change in the price of the index futurescontract is necessary before an investorshould venture into investing some of themoney in futures contract.

COMMODITIESre s> mby.h e

Physicals, where the goods exist and aredelivered immediately.

Futures, where the goods may not yetexist and will only be delivered in thefuture.

The commodity markets exist primarily forcommercial buyers and sellers of thecommodity concerned. They can be bought as:

An investor may try tomake money by buyinga commodity future, which is the right to havea certain quantity of commodity at a fixeddate in the future. The investor will be hopingthat the market prices will rise so that whenthe goods are delivered he will be able to sellimmediately at a profit. He will not beinterested in the goods themselves and willalmost certainly never see them.Commodity prices can be very volatile as theydepend on supply and demand as well as onother variable factors such as the weather orunexpected pests attacks. For example a newpest may reduce a crop, thus greatly increaseprices for the crop to be harvested in a fewmonths time. Large profits can be madefrom commodity futures. Equally largelosses can occur, although there will always bethe underlying physical goods to prevent atotal loss.As well as dealing directly in. commoditiesan investor can deal in commodity options,which work in a similar way to share options.

Investors can invest via commodity brokers ina number of markets such as palm oil, coffee,tea, beans etc.

3.9.1 ADVANTAGES ANDDISADVANTAGESWith a low outlay, the investor can get veryhigh profits. Profits can be made both during

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--------------------~Q]~-------------------TYPES OF INVESTMENT ASSETS

rising or falling market. However,commodities trading is very high risk.

Pi.,LIFE INSURANCE

Life insurance is intimately connected withthe national interest because it is a means ofalleviation of the financial distress that deathmay bring and a method of saving and, to adegree, of investing. Its importance to thecommunity is recognised by the governmentas evidence by the relief of income tax on lifeinsurance premium and benefits under thelife policies.Life insurance may be pictured as a pool offund into which a large number ofpolicyowners jointly contribute in relation totheir risk-exposures, in order that a specifiedsum ofmoney willbe paid from the pool on thedeath or other contingencies dependent onhuman life. The life office agrees to pay theassured the sum assured and any accrued.bonus o~ the happening of spe~ified insuredevents; such as the death of the life assured orhis survival to the end of the life insurancecontract. The policyowners, on the other hand,agree to pay the premium periodically to thelife office for a specified term or until thedeath of the life assured or they mayalternately pay a lump sum at the inception ofthe life insurance contract.

3.10.1 BASICFORMSOF LIFEINSURANCECOVER

There are basically four basic forms of lifeinsurance cover, and the numerous policies

available are combinations or modifications ofthese:a. Term (or Temporary) insurance;b. Whole life insurance;c. Endowment insurance; andd. Annuity (discussed under 3.U-Annuities)

3.10.1.1 Term Insurance PolicyTerm or temporary insurance is the simplestand cheapest type of life insurance. The policyprovides for payment of the sum assuredonly if the life assured dies '~ithin aspecified period. If the life assured survivesthe period, the policy ceases, and there is noreturn of premiums paid. There is also nosurrender or cash values available on earlytermination.The premiums payable for term insurancepolicy are, therefore, solely for the purpose ofproviding life cover as a form of protection.This type of policy is often used to cover adebt, example the capital sum outstanding ona repayment house .mortgage.

3.10.1.2 WholeLife PolicyThe sum assured under whole life policy ispayable on the death of the life assured, andthe premiums may be payable throughout life,or may cease at a selected age. The premiumspayable provide a mixture of life cover andinvestment. With', interest earned under thepolicy, cash values are built-up which can bewithdrawn or borrowed.

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26/90

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Whole life policy cash values can bewithdrawn at any time by the policyownercanceling and surrendering the policy.Alternatively, if the policyowner does not wantto surrender the policy, the policyowner canstill have access to accumulated policysavings. This can be done by obtaining a loanfrom the life office under the policy for anyamount up to that of the cash value.Whole life insurance is the ideal form ofinsurance for the man with dependentrelatives, as substantial life cover is obtainablefor the amount of premium payable.

3.10.1.3 Endowment PolicyUnder the endowment policy, the sum assuredbecomes payable at a maturity date (on theexpiry of a fixed term, say 15, 25 or ~5 years),or at death of the life assured before thatmaturity date .Like the whole life policy, the premiumspayable for an endowment policy provide amixture of life cover and investment, thuscash values are built-up which can bewithdrawn or borrowed.

3.10.2 WHOLE LIFE ANDENDOWMENTPOLICIES ASINVESTMENTVEHICLE

With its interests earning capacity, both wholelife and endowment policies are effectivelymaking an investment which returns becomepayable at a future date: either on death orearlier.Both whole life and endowment policiesmay be for a guaranteed return only, in

which case they are known as non-profitor non-participating. On the other hand,the return can be linked to the lifeoffice's investment performance. This can bedone either by having a traditional with-profitlife policy - where benefits are indirectlyaffected by investment performance of the lifeoffice, or by having an investment-linked lifeinsurance policy - where the linked withinvestment performance of the life officeis direct.

P "ANNUITIESLife insurance has as its principal aim thecreating of an estate, or accumulation of alump sum fund. Annuity, on the other hand,has as its basic function the systematicliquidation of a fund which has been created.Life annuity may be described as the oppositeof insurance protection against death. In itspurest form, a life annuity is a contractwhereby for a cash consideration, the insureragrees to pay the named life annuitant astipulated sum, called the 'annuity,periodically during a fixed period of time or forthe duration of survival of the designated life(the annuitant) or lives, .with theunderstanding that the principal sumstanding to the credit of the annuitant shallbe considered liquidated immediately upon'the death of the annuitant.A person could not be certain of not survivingbeyond his calculated life expectancy, thus thepurpose of buying annuities is to protectagainst the risk of outliving of the person'sincome by living too long.

i!~i 3/14


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Most annuities are attractive savingsinstruments for any person who has not yetaccumulated an estate but wants to achievefinancial independence in his old age, asannuities are designed to first accumulate fundsand then to systematically liquidate the funds,usually during the annuitant's retirement years.For people who have already accumulated anestate, either through inheritance or by theirown efforts, can purchase annuities as a hedgeagainst adverse financial developments.Estates can be wrecked through businessreverses, unwise investments andmanagement. Such individuals would thendepend on the payments from annuitiespurchased in their more aflluent days as theirsole source of income.

3.11.1 TYPESOFANNUITIES

There are twobasic types of annuities, and thenumerous contracts available aremodifications of these: Immediate annuity Deferred annuity

3.11.1.1 Immediate AnnuityAn immediate annuity contract provides, inreturn for a single premium, an annualpayment starting immediately and continuingfor the rest of the annuitant's life.Immediate annuity contracts are oftenpurchased by retired people who want anincome that is guaranteed to last for the rest

of their life, no matter how long (or short) thatmay be.

3.11.1.2 Deferred AnnuityA deferred annuity is a contract whichprovides for all annuity to be payablecommencing at some future date. The periodbetween the date of the contract and the datethe annuity is to commence (often called thevesting date or the maturity date) is known asthe deferred period. Often, regular premiumsare payable throughout the deferred period. Ifthe annuitant dies during the deferred periodthe insurance office will usually return thepremiums paid, with or without interest. Oncethe vesting date is reached the annuitybecomes payable and will continue for the restof the annuitant's life.Many deferred annuities are effected inconnection with pension schemes or personalpension contracts. Full cash options will notbe available in those cases.

atjADVANTAGES ANDDISADVANTAGES OF LIFEINSURANCE AND ANNUITIES

Life insurance and annuities are generallysafe investment vehicles as they give aguaranteed lump sum payment or regularincome. However, some of the build-in chargescan be expensive.

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---------4---------INVESTMENT-LINKED LIFE INSURANCE PRODUCTS

- AWORLD SCENARIO

.. In United Kingdom IN UNITED KINGDOM

... In The United States ofAmerica

.. In Singapore The investment-linked life insurance businesshas been transacted in the United Kingdomformore t~~~ 30 r~~rs. Over this period therehas been considerable evolution in the designof the products culminating in the currentflexible investment-linked whole life planswhich allow the policyowner total flexibility toalter hi~ 'need~ for investment and protectionin accordance to his wishes.

... In Malaysia

The first investment-linked life insurancecontract in the United Kingdom was anindividual retirement annuity. for the self-e~pl~yed. Itwas intro'd~ced by the London &~-- . .Manchester Assurance Company Limited in1957. investment was linked to an externalunit.trust.By 1960 there were six companies offeringinvestment-linked life insurance contracts.with total new annual premiums of under500,000 and virtually no single premiumspolicies. By 1970 the number of insurers hadgrown to 91 and new annual premiumstotaled 25 million with an additional 53million in single premiums.In 1986 approximately 130 companies werewriting investment-linked life insurancebusiness with total new annual premiums of543 million and single premiums of 4,448million. These figures only relate to ordinarylife policies and exclude investment-linkedexecutive pension plans that have also been a

4/1

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major growth area in recent years. Theinvestment-linked life insurance business in1986 represented 30% of all new annualisedlife premiums.The early investment-linked plans wereconstructed in a similar way to traditionalendowment po~~~ieswith the objective of.--..-~. -~- .. . ------,- ..--providing a saving fund at the. end of a;pecifled p~rio~e.g. 10, 15, 20 or 2 5 Y~a~s..-"Life insurance cover was built in on a similarbasis in order to be comparable with the stillpopular endowment with profits. The suminsured (face amount) usually remained levelso that the actual amount of risk benefitprovided was in reality a decreasing terminsurance to supplement the value of theunderlying investments.

iIII,r[l

However, the greater cost of the life cover at.the older ::t~esobviously detracted from the-iiiv"estment values for those who wereprimarily interested in the investment aspectand only regarded the life insurance elementas necessary to obtain the substantial taxrelief on the premiums.A breed of policy therefore grew up wherebythe life insurance cover was only sufficient tomake the policy quallflJt?r. tax relief (i.e, lifecover of 75% ofpremiums payable).The life cover was still a decreasing terminsurance and often the actual term insurancecover would be extinguished as theinvestment values surpassed the guaranteedsum insured. In some cases this could occuras early as 5years on a lO-year duration policy.The short-term (e.g. 10 years) policies werevery much geared to investment and hencethere was very little room in the margins to

pay high initial commissions - usually about25% and rarely more than 40%.Thus a significant proportion of investment-linked plans both for investment andprotection were (and continue) to be sold forlonger terms (20 years -). However, the lifeinsurers realised that there was no longer anyneed to have a fixed maturity date.By making the policies "open-ended", thepolicyowner could cash in hislher investmentsat anytime (usually without surrenderpenalty after 10 years) and, it was hoped,leave the funds with the insurer for longerthan perhaps had been originally intended.Cash values at various duration would beshown in the sales literature when the salespresentation was geared to a fixed termsavings concept. For those who requiredadditional protection, supplementary terminsurance or family income benefits would beadded to the basic guaranteed sum insuredunder the investment-linked life insurancepolicies.A new generation. of investment-linked lifeinsurance products evolved in the mid 1970's.Up to that time investment-linked lifeinsurance business had an image of being"risky" as there were few guarantees in theproducts and in particular there was little tocompete with traditional whole life insurancewith high guaranteed sums assured.The first of the new generation of investment-linked life insurance products was really theHambro Whole Life Plan introduced in 197.7.This was an investment-linked whole life planwhereby the sum insured was guaranteed fora given investment of premium for the first10years.

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-------------------~~------------------INVESTMENTLINKED LIFE INSURANCE PRODUCTS - A WORLD SCENARIO

At that point (and at 5 yearly intervalsthereafter) an actuarial review of the policywould take place. Hambro Life stated that aslong as the investment growth was at least71/ % compound and that insureds' mortalitydi: not deteriorate from the then publishedmortality tables of the Institute of Actuariesthey would renew the sum insured/premiumguarantee for a further 5-year period.Because they were able to dispense with thelong term investment and mortalityguarantees, Hambro were ab~e.to discount .asmuch as one third offthe traditional whole hfepremium rate. For the first time the charge forthe mortality cost was deducted each year ona current cost basis by canceling the requirednumber of investments.The Hambro Whole Life Plan was itselfsuperseded as the "state of the art" plan twoyears later in 1979 by Skandia Life UK.Whereas the Hambro plan had a fixed sumassured per investment of premiumsaccording to age at entry, the Skandia planallowed the policyowner to select whateversum insured the policyowner required withina given range of cover.i.

The marketing of variable life was pioneeredby the ~quita!>l~_~tf~ Al?I?}1X.aPCf3.Society butthe initial success was quite limited. In 1991,variable life insurance accounted for 8%of theindividual life market and 28% of theindividual annuity market. Whole life (56%),universal life (24%) and term life (12%)madeup the balance of the individual life market,and fixed annuities (72%) accounted for thebalance of the individual annuity market.Compared to the traditional products,variable life insurance was more affected byregulations in the United States. Apart fromstate insurance laws and regulations, variablelife contracts are also subject to federalsecurities laws and are- regulated by theSecurities and Exchange Commission.Principally, the securities laws governingvariable life insurance are the InvestmentCompany Act, 1940, the Securities Act, '1933and the Securities Exchange Act, 1934.The Investment Company Act, 1940 regardsentities that investment assets of variable lifeinsurance policyowners as investmentcompanies. This Act regulates the investmentcompany's marriage merit and operation.The Securities Act, 1933 requires 'thatpotential clients be provided witha prospectusthat among others discloses the identity andnature of the insurer's business, how thepremiums are going to be invested, financialinformation of the insurer, chargeable fees andexpenses and rights of policyowners.Under the Securities Exchange Act,.1~~4; theinsurance company or the sales companymust register as a broker-dealer, The Actrequires that agents ~and agency officeemployees pass an examination in secu~tiesbusiness. Additionally, they must register withthe National Association of Securities Dealers(NASD) and pass an examination.

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IN THE UNITED STATES OFAMERICAVariable life insurance, which investment--liiuted life insur~~e is more commonly calledin the United States, was offered for sale tothe general public in the US in 1976. This wasafter the investment-linked life insuranceproducts had been successfully marketed inTl1e Netherlands, United Kingd?m andCanada.

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previously reserved only for the EIS scheme.Among the life insurance policies, ~nlyendowment policies were approved by theCPF' Board 'as eligible investment instrument.This is because of the general focus ofendowment policies on investment returns,'unlike whole life or term insurance policieswhere a substantial part, if not the whole ofthe cost, is used to provide death benefits.

IN SINGAPORE

The first single premium investment-linkedpolicy introduced in Singapore was in~~92~~byNTUC Income. In 1992, Prudential joined theinvest~ent-linked life insurance market withthe single and regular premium products. Thiswas followed thereafter by some other lifeinsurance companies who added investment-linked life insurance business to theirportfolio. In the last few years, sales ofinvestment-linked life insurance business inSingapore have grown significantly.One of the factors which contributed to theexpansion in Singapore of the life insuranceindustry, including investment-linked lifeinsurance business, was the introduction" ofthe Enhanced Investment Scheme (EiS) bythe Central Provident Fund (CPF) in 199.3.This scheme enables CPF members who havecash of at least S$50,000 in their Ordinaryaccount, to invest :80% of the excess in theOrdinary account above S$50,000, in one ormore of the eligible investment instruments.Life insurance policy is one of the eligibleinvestment instruments under this scheme.In 1997, two existing investment schemes ofthe CPF, that is the EIS and the BasicInvestment Scheme (BIS) merged to form anew scheme known as the Investment Scheme(IS). The introduction of this scheme allows~~re CPF members to invest in a wider rangeof investment instruments. All CPF memberswho retain at least the 'required minimumsum in their CPF accounts, including the cashamount will be allowed to invest up to 80% oftheir remaining CPF balance in all the eligibleinstruments, including those which were

IN MALAYSIA

Investment-linked life insurance products arevery new in Malaysia. Syarikat TakafulMalaysia Sdn Bhdjriow Syarikat TakafulMalaysia Bhd) first sold-a simplified form ofinvestment-linked life insurance product tothe public in ~ugust198Q., MNI Takaful SdnBhd, a subsidiary of Malaysian NationalInsurance Bhd, followed this in 1994.The products developed by' the Takaful(I~lamic insurance) companies were not due tofinancial considerations or con~umerdemands, instead they were developed as aresponse to the religious principles andpractices of the Muslims. The premiumsreceived fromTakaful policies are invested instocks and other assets that comply with therequirements of Islamic law.Investments thatdo not conform to Islamic law includebusinesses that deal with liquor, gamblingand whose primary line of business isinterest-based.In July 1997, Berjaya Prudential AssuranceBhd became the first traditional insurancecompany to launched the investment-linked

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--------------~[O~---------------INVESTMENTLINKED LIFE INSURANCE PRODUCTS-A WORLD SCENARIO

life insurance product. The product BerjayaPrudential Assurance introduced is the._!!ngle-premium wh.Qleof life insurance product:--

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Mayban Life Assurance Bhd was givenapproval in February 1998 to transactinvestment-linked life insurance business.The product launched by Mayban LifeAssurance is the unitised investment plan(bancassurance) which uses the up-frontinterests earned under fixed deposit accountsof not less than RMIO,OOO with Maybank toinvest in the investment-linked product.

Death and total permanent disability benefitsare based on term life insurance.The next insurance company to be given theapproval to underwrite investment-linked lifeinsurance was Malaysian Assurance AllianceBhd.Several other insurance companies are in theprocess of seeking approval from the CentralBank, Bank Negara Malaysia to underwriteinvestment-linked life insurance business.

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---------5---------TYPES OF INVESTMENT-LINKED LIFE INSURANCE

PRODUCTS

.. M Introduction ..". Definitions..... Characteristics ofInvestment-linked

Life Insurance Policies .,. Types of Investment-linked LifeInsurance Policies .,... Loans and Withdrawals of

Investment-linked Life InsurancePolicies

Comment

INTRODUCTION

Investment-linked life insurance policies wereintroduced in Malaysia, as in many othercountries that underwrite such business, as away of offering policyowners life insurancepolicies with values directly linked toinvestment performance. This is usually doneby linking the value of the policy to units in aspecial unitised fund managed by the lifeoffice.Alternatively, the link can be to the units of aunit-trust. The values of the units directlyreflect the values of the .underlying assets ofthe fund, and fluctuate daily (perhaps evenmonthly) according to the performance ofthose investments.

5.1.1 HOWDO INVESTMENT-LINKEDLIFE INSURANCE POLICmS WORK?

Investment-linked life insurance policiesoperate on similar principle as unit-trust. Ininvestment-linked life insurance, a majorportion of the policy premium are used topurchase units in the investment-linked fundmanaged by the life offices.A lesser part of thepremiums will be allocated for the mortalityprotection aspects under the policy.The investment returns under investment-linked life insurance policies are notguaranteed. They are linked to theperformance of an investment fund managed

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by the life office. Ownership of the fund is sub-divided into units, each of which represents anequal share of the net asset value of the fund.The fund invests in assets that fluctuate invalue as market prices rise and fall. As theasset value of the fund rises, the unit priceincrease. As the asset values of the fund falls,so does the unit price. The policies thereforelack the smoothing process of the traditionalwith-profit life policies and instead reflect theinvestment performance actually achievedwith the policyowners' money. Differentgenerations of policyowners receive differentresults. Some do better than others, and it ispossible to lose money .

of

Each premium that the policyowners make isallocated to units at the unit price prevailingon each investment date. Units are allocatedat the life office's selling price (called .o.tI.erRri~e - discussed urider .5.2 on Definitions).When units are cashed to meet death,maturity, surrender claims or expenses, theyare cashed at the life office's buying price(called bid price-discussed under 5.2 onDefinitions). In the case of life funds, thedifference between the offer and bid prices innormal market conditions is 5o/(r-6% of theoffer price. This differenceis.know asthe.bid-offer spread (discussed under 5.2Definitions).

a. traditional with-profit life policies aim toproduce a steady return by smoothing outmarket fluctuations. Investment-linked lifeinsurance policies offer the potential forhigher returns but at the expense ofmarketvolatility and a higher degree of ~sk,although this risk is considerably less iftheinvestment-linked life insurance policyinvests in a managed fund which has abroadly similar investment portfolio as atraditional with-profit life fund (forexample, government bonds, sharesand property).

b . investment-linked life insurance policiesare likely to offer far more choice in termsof the type of investment funds (forexample, shares, government bonds,property or a mix of all these).investment-linked life insurance policiesmayor may not be more flexible than thetraditional with-profit life insurancepolicy.the investment element of investment-linked life insurance policies is madeknown to the policyowner at the outsetand is invested in a separately identifiablefund, which is made up of units ofinvestment.

Under traditional with-profit life policies,each premium is made up of several elements,one part to provide insurance protectionagainst death, another to cover expenses andsales cost, and the bulk of the premium to beinvested. The premium apportionment ofinvestment-linked life insurance policies issirnilar. The fundamental differences,however, are

c.

d .

e .

Unlike traditional with-profit lifepolicies, the peaks and troughs ofinvestment returns of investment-linked life insurance policies are notadjusted to provide policyowners with asmoothed rate of return, as the netbenefits and risks of investmentreturns are immediately passed topolicyowners.the structure of policy charges and theinvestment content of investment-linkedlife insurance policy are more identifiable

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------------------~~r-------------------TYPES OF INVESTMENT-LINKED LIFE INSURANCE PRODUCTS

by the policyowners as they are specifiedin the investment-linked life insurancepolicydocument. Policy fees, initial set-upcost, mortality charges and the amountset aside for investment (and theinvestment charges) can be determinedby a careful study of the policydocument and policy statement. However,in the long term charges are likely tobe similar.

Under traditional with-profit life policies, theexpenses of running a life officeand acquiringbusiness are covered by making certaincharges on the policies issued, both 'up-front'and regular policy charges. Such chargesunder traditional with-profit life policiesare not specifically detailed in the policyterms. The polieyowner bears some of thesecharges directly in relation to his particularpolicy; others are taken out of the life fundas a whole.By contrast, charges levy on investment-linked life insurance policies are stipulateopenly including the types and level of chargesimposedbythe lifeoffices.The charges are likelyto be a combination of. two or more of thefollowing: Policy fee Annual fund management fee Bid-offer spread Reduction in allocation of units

Unallocated premiums Initial units Mortality charges Surrender charges

DEFINITIONS

5.2.1 POLICY FEEThe policy fee payable by the policyowner isthe same as for traditional life insurancepolicies. It covers the administrative expensesof setting up the policy.As the cost of settingup a big or small policy is almost the same, thelife office will normally levy a uniform policyfee on each policy.

5.2.2 ANNUAL FUND MANAGEMENTFEE

The management of the investment-linkedfund is handled by professional investmentmanagers. A deduction of a percentage of theinvestment-linked fund accumulated within apolicy's holding of investment units to coverinvestment management charges will bemade. This could be between 0.5% to 2%of the~nd each year.

5.2.3 OFFER PRICEThe offer price is the price at which unitsunder an investment-linked life insurancepolicy are offered for sale by the life office. Ithe offer price is RMI and the whole premiunamount of say RMIOO is to be used to bu:units, it will buy 100 units.

5.2.4 BIDPRICEThe bid price is the price at which the unitunder an investment-linked life insu;;n(

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policy a~cashed when the policy m~~:es, orwhen the policy is surrendered, or at whichunits are cashed to pay-for charges under thepolicy.Bid price is always lower than the offerprice at the published date. Assuming thatthere is no other charges levied, 100 units canbe claimed for RM95 if the bid priceis RMO.95.

5.2.5 BID-OFFER SPREADThere is commonly a difference betweenoffer price and bid price, with the offer pricebeing higher than the bid price, usuallyfalling between 5% to 6% of the offer price.This difference is known as the bid-offer spreadand is an effective initial charge of5% or 6% bythe life office to the policyowner 01) everypremium made to cover expenses in setting upthe policy.

5.2.6 REDUCTION IN ALLOCATIONOF~TS-UNALLOCATEDPREMIUMSUnder this form of charge the life office doesnot use all of a policyowner's premiums to buyinvestment units. The difference representingthe life office's charge to meet marketing andsetting-up expenses of the policy. Thus apolicyowner may find that only, say 60% ofeach premium is used to purchase investmentunits, in say,the first year or two of the-policycontract. Some insurers make nil allocation tounits until their initial charges have beenrecouped.

5.2.7 INITIALUNITSAlternatively, a life office may allocate all ofthe policyowner's premium to units. However,the units allocated in the early years will beknown as 'initial units' and will have higherannual management .charges such as 6% perannum through out the term of the policycontract. Initial units bear heavydiscontinuance charges and their cash valueis much lower than their face value for years.This method is much less common these daysthan in the past.

5.2.8 MORTALITY CHARGESThis cover the mortality costs ofthe policy andis, therefore, dependent on age. It is possiblefor the mortality charge to be a recurrentcharge (e.g. monthly). In this event, themortality cost is funded by cancellation .ofunits on a regular basis, and the life companycan then allow the policyowner to vary thesum assured over time.

5.2.9 SURRENDER CHARGES

This is a charge deducted from the value ofunits at surrender and is applicable to policieswith uniform allocation. It represents initialexpenses which have already been incurredbut not yet recovered.

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--------------------GJr-------------------TYPES OF INVESTMENTLINKED LIFE INSURANCE PRODUCTS

CHARACTERISTICS OFINVESTMENTLINKED LIFEINSURANCE POLICIES

The characteristics ofall formsofinvestment-linked life insurance policiescan be groupedas follows:a. Investment-linked life insurance policies

can be used for investments, regulars~vings and protec~on. The protectionelement may take the formof life cover,total and permanent disability,accidentaldeath or personal accident benefit andpersonal health insurance.

b. Investment-linked life insurance policiesgenerally(althoughnot necessary)have alarger exposure to equity investmentsthan traditional with~p~~fitand other lifeinsurance policies.

c. The cash value and protection benefitsare determined by the investmentperformanceofthe underlying assets andthis performance is reflected by theprices of the units in the investment-linked fund.

d. Theprotection costsare generallymet byexplicit charges (i.e. types and level ofcharges imposed by the life office arestipulated openly in the policy terms),which vary with age and level of cover,and are coveredby cancellation of unitsin the fund except for single premiumplans where they may be met by a flatinitial charge.

e. Commissionsand officeexpensesare alsometbya variety of explicit charges, some

ofwhichwillnormallybevariable but thelife office must normally give a sixmonths' notice prior to any change.

f. The cash value is normally the value ofunits allocate to the policyowner,calculated at the bidprice.

TYPES OF INVESTMENTLINKEDLIFE INSURANCE POLICIES

Although there are numerous variationsand types of investment-linked lifeinsurance policies available in theoverseas market, which major types wewill describe below,the basic types currentlybeing sold in Malaysia are limited to thesingle premium life insurance plans (where a'one-off' contribution to the policy is made)and the regular premium life insuranceplans (where premiums are paid in moreregular intervals). The followingare some ofthe major investment-linked life insurancepolicies: Single Premium Investment-linked

WholeLife Plan Regular Premium Investment-linked

WholeLifePlan Investment-linked Individual PensionPlan

Investment-linked Permanent HealthInsurance

Investment-linked Dread DiseaseInsurance

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5.4.1 SINGLE PREMIUM.INVESTMENT-LINKED WHOLE LIFEINSURANCE PLAN

A number of insurance policies andcombination of policies can be used as singlepremium investments. Typical investmentsare single premium investment-linked wholelife insurance plan, where a 'Qne-_Q.ff'remiumcontribution is made to the policy which usesthe premium to purchase units in aninvestment-linked or unitised fund andprovides a certain level of life cover.InMalaysia, single premium policies must atleast have a minimum premium of RM3,000(discussed under 10.3 - Law CoveringInvestment-linked Life Insurance)Single premium investment-linked whole lifeplan is one of the first type of investment-linkedlife insurance policies available. It is simple indesign. The amount of insurance protection is apercentage (usually 125%) of the singlepremium paid, and is subject to a minimumamount (inMalaysia this is RM5,000).The emphasis for single premium investment-linked whole life plan is normally on Jqng-term savings and investment. Thus, the planoffers only nominal life protection.Administration and insurance charges orcosts are recovered by imposing policy fees,other administrative .charges and mortalitycharges. The investment-linked fund wouldnormally incur an investment managementfeeof 0.5% to2%per annum, depending on thetype of fund and the bid - offer spread.Top-ups or single premium injections areusually allowed.

The policyowner has the right to surrenderpart or whole of the units allocated to him.This is attractive to investors who want tohave easy access to their funds.

/' _ _ -- -5.4.2 REGULARPREMIUMINVESTMENT-LINKED WHOLE LIFEINSURANCE PLANThe scope of regular premium investment-linked whole life insurance plan is similar tothat of single premium investment-linkedwhole life. The exception is that instead of thepremiums being paid in a lump sum, the~remiums under this plan are paid at r!@J?!l!l.~~als, either monthly, quarterly or annually.Units in the investment-linked or unitisedfund would be purchased' as premium arereceived. The plan serves two distinctpurposes - investment and life protection,with life protection as the main objective ofthe plan.Premium holidays and top-ups, subject to thelife office's administrative rules are usuallyallowed. Withdrawals and surrenders areallowed, usually after a few years' premiumshave been paid. .

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5.4.3 INVESTMENT-LINKEDINDIVIDUAL PENSION PLANThe basic investment-linked individualpension plan usually involves a highallocation of the premium contributions toinvestments through simply accumulating thefund to retirement, when the fund is thenused to purchase either a traditional annuityor an investment-linked annuity.

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Conventionally, there is usually no life

- - - - -~~~~~~c~c~~erin the basic plan other than areturn of investment funds on death. Lifecover-canbe-pr~~ded-byt~king up a separateterm insurance policy.Recent development saw the latestinvestment-linked individual pension plansbeing launched with the life insurance coverbeing funded by cancellation of investmentson the pension plan.

A further development is the introduction ofinvestment-linked individual pension planswhereall or part ofthe funds canbe convertedinto a traditional with-profit life insurancepolicyas an alternative to switching into otherinvestment-linked funds.Such plans are popular overseas as there aretax advantages for employees' owncontributions to these plans. The governmentsconcerned want to encourage savings bygivingtax incentives. F:}..

5.4.4 INVESTMENT-LINKEDPERMANENT HEALTH INSURANCE

Some life offices have created other types ofinvestment-linked plans. Instead ofprovidingthe usual death coverage, they offer otherforms of coverage such as permanent healthand dread diseaselliving insurance.The investment-linked permanent healthinsurance: provides health coverage such as

disability income. contains cash _value unlike traditional

health products that does not have cashvalue.

A new investment-linked life insuranceproduct which incorporates long termdisability income benefits is now available inthe overseas market. This product is pricedvery competitively when compared totraditional with-profit lifeinsurance products,sometimes by as much as 25% offthe costs oftraditional with-profit life insurance productsin strong economicenvironment.The product design of this investment-linkedpermanent health insurance also has theadvantage of offering cash value despite_hecompetitive price.This newproduct has takenthe UKmarket by storm.Within 12months oflaunch, AlliedDunbar's product has capturedan estimated 34% of the entire individualpermanent health insurance (PHI)market.The first universal life long term disabilityplans are nowbeginning to appear in the USAand their design followed that of the UKversion.

5.4.5 INVESTMENT-LINKED DREADDISEASE INSURANCE

One of the most successful innovation ininvestment-linked life insurance productdesign in the UK was Living Assurance byAbbey Life Company. It is a life insurancepolicy which advances the whole of theface amount in the event of the diagnosis of aheart attack, stroke, coronary artery by pass,end stage renal failure or total permanentdisablement. The risk cost of the dreaddiseases cover is reviewed on a regularbasis and improved product benefits orpremium are passed to the policyownerin theevent of better than expected claims orinvestment

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