When it comes to life and disability insurance, beware the upfront costs. So says Ross Smith, broker with Shenton Ltd, who claims that the post-second world war life insurance system still governing Hong Kong's life cover is a net destroyer of investor wealth. If sold for the wrong reasons, Investment-Linked Assurance Schemes (ILAS) can lead to consumers losing a lot of money down a black hole. The danger of buying an ILAS, warns Smith, is that it won't match an individual's investment requirements or their need for adequate insurance or disability cover. He says while ILAS can result in a waste of hard-earned wealth, the companies responsible for providing them are brimming with happiness. 'That's because they're designed using an actuarial formula conceived before the industrial revolution, when inflation was not measured and assets were held at original book [purchase] value,' says Smith. 'This means policyholders miss out on future capital appreciation, while the reserves retained by the life company balloon sky high.' In a recent circular, the Securities and Futures Commission (SFC) also highlighted the dangers associated with buying ILAS products. One of the SFC's many concerns was that the premium payments made by policyholders are first applied in respect of fees and commissions, with the balance being paid to the insurer. Strangely, the SFC doesn't regard units in ILAS as securities, and states: 'If, as is normally the case, an insurer places a percentage of the premium payments received into such funds, these investments are for the account of the insurer itself - the policyholder has no interest in them whatsoever.' In theory, an insurance company could gamble with a consumer's money. But in practice, Roger Steel, deputy chairman of the Life Insurance Council, says that when the consumer instructs the purchase of XYZ investment products, the insurance company is required by prudential authority to comply in strict accordance with those instructions. Steel says that when complaints do arise on ILAS products, they typically relate to how it's being sold than to the product itself. As expected, advisers are required to understand the needs and risk profiles of customers and comply with strict disclosure requirements about the product nature and features. However sometimes, he says, the advice given is inappropriate. For every broker in Hong Kong, Smith suspects there are 20 agents whose sole aim is to sell long-term ILAS products with expensive premiums, and negligible protection. While brokers and financial advisers can typically be relied on to provide comprehensive and independent advice, he says the same cannot be said for agents. In light of these concerns, Money Magazine identified 10 key tips to help consumers better understand ILAS products before buying them. 1) Paying too much for too little: As insurers are not required to disclose Policy charges and commission, policyholders have no way of knowing how much they're paying in total. However, Smith says they need to know that it's common practice for the insurer to pay three times the annual premium (on longer-term ILAS) to an agent or broker as a sign-up fee. 2) Too little too late: Admittedly, cash paid in as premiums can be returned after 13 years, but all too often, Smith says, policies don't last long enough for this to happen. That's because investors who stop or change their ILAS are significantly disadvantaged for doing so. As a case in point, Smith recently advised a client - who after nine years was still down HK$15,000 - to cancel her policy and put the corresponding amount into her mandatory provident fund (MPF) account. If she stayed with this policy until age 99 she stood to receive around HK$1 million, but as she has no dependents, Smith says the money arrives too late for it to be of real value. 3) Next best alternative: Expatriate workers are advised to organise cross-border insurance cover in their home of origin before arriving in Hong Kong. But Smith says Hong Kong nationals would be better off putting their money into a low-fee paying MPF account, rather than paying into a long-term ILAS to try to emulate whole-of-life cover characteristics. 'Investors who adopt this strategy stand to get three times as much in 20 years,' says Smith. 4) Mismatch: Couples in their fifties who have paid off their mortgage remain saddled with an ILAS product they simply no longer or possibly never really needed. He doubts whether many of these policyholders realise that the investment aspect of their ILAS isn't linked to binding policy contracts. 'Life cover should be the dominant factor motivating policyholders to acquire an ILAS as there are many pure investment products on the market with lower initial charges, more flexibility, and without penalties for early termination,' says Smith. 5) What's really covered: Critical illness cover has had a strong uptake since its launch onto the Hong Kong market 15 years ago. However, Smith warns investors to closely read the small print. What's commonly overlooked is that disability income protection is only available for the first 24 months, after which individuals need to prove they cannot perform any occupation at all. People looking for disability insurance can only receive it as a 'rider' or add-on once they have taken out their cover first. But what policyholders typically don't understand, adds Smith is that all a 'disability rider' will do is continue to pay the premium on policy in the event of any disability claim. 'This is yet another example which shows that the system governing some ILAS products is designed to ensure the payment of policies as long as possible,' he says. 6) Don't cry over unrecoverable losses: Policyholders are reluctant to cut their losses and close their ILAS accounts until the penny finally drops - it will never be recovered simply by keeping the policy open. So it's better to kiss goodbye to money that will never be recovered, than to go on throwing good money after bad. 'I encourage policyholders sceptical about cutting their losses to do the maths,' he says. If 7) Seek quality independent advice: Far from being a dirty word, ILAS does service a real niche, says Rainbow Pan, CEO with ipac. However, she agrees with Steel that the problem isn't really with ILAS, but how it's being sold. 'Those selling this product haven't always done their best by consumers,' says Pan. 'Agents who don't get a base salary haven't always got the right approach to selling this product.' The magnitude of up-front fees may attract the churn of agents out for a quick buck. But she says this is more prevalent with ILAS used as long-term savings plans because the commissions are a lot higher. Pan also concedes that while ILAS do offer investment choices, they are considerably more expensive. 'That's why for normal investors a pure investment platform is a more suitable option.' So before buying ILAS products, look carefully at the associated charges, and how long they're going to have to pay them. 'It comes down to what's affordable over what period of time,' says Steel. 'If advisers are trying to sell ILAS with premium payments required beyond age 65, then something is not right.' 8) Too young or old to bother: anyone who earns an income and has a mortgage, dependent family or private school fees should protect their lifestyle through adequate risk cover, regardless of age. 'Twenty eight percent of employed professionals between 40 and 65 are likely to suffer from life threatening critical illness or total disability, compared to a four per cent probability of death.' 9) Understand 'investment' risk: Instead of a pre-set death benefit, as usually found in a whole-of-life or endowment or term life policy, the policy value within ILAS is linked to underlying funds of the policy selected by the policyholder - which can go down or up. That's why Eric Lee, secretariat with the Hong Kong Confederation of Insurance Brokers (HKCIB), says it's important to remind policyholders that they are taking up an 'investment' risk. Otherwise referred to as '101 products', Steel reminds consumers that standard ILAS typically pay only an additional benefit on death of just one per cent of the account balance - which fluctuates constantly. 'Essentially, the basic ILAS product is not intended to provide more than minimal insurance cover, unless additional benefits are deliberately chosen.' 10) Horses for courses: Despite not being risk-free, Lee also reminds investors that ILAS products carry merits and do answer to the financial needs of some groups of clientele, notably estate planning. Given that there's no social security in Hong Kong, and many people don't like making wills, Pan says ILAS can also complement more complicated family situations where a couple may be supporting themselves and two other generations.