10.4 ILP Unit Pricing, Funds and Sustainability

Study Focus

NAV per unit reflects net fund assets divided by outstanding units. Single pricing separates unit valuation from disclosed charges.

Unit Pricing Mechanisms: Dual Pricing vs. Single Pricing Reform

A critical technical topic tested on the PCEIA examination is the historical evolution of unit pricing in the Malaysian insurance market.

The Historical Dual Pricing System (The Bid-Offer Spread)

Prior to regulatory reform, Malaysian investment-linked policies operated under a dual pricing mechanism:

• Offer Price: The price at which units were sold by the insurer to the policyholder (the purchase price). This was the higher price.
• Bid Price: The price at which units were bought back (redeemed) by the insurer from the policyholder when deducting mortality charges, processing withdrawals, or settling surrenders. This was the lower price.
• The Bid-Offer Spread: The difference between the Offer Price and the Bid Price was known as the Bid-Offer Spread, which LIAM describes as usually around 5% of the Offer Price:

$$\text{Bid Price} = \text{Offer Price} \times (1 - 0.05) = \text{Offer Price} \times 0.95$$ $$\text{Offer Price} = \frac{\text{Bid Price}}{0.95}$$

This 5% spread acted as an implicit, disguised front-end initial charge deducted every time units were acquired.

The Modern Single Pricing System

To improve transparency, Malaysian ILPs now generally use a Single Pricing System, with charges disclosed explicitly. BNM's Policy Document on Investment-linked Business (latest version issued on 13 February 2023) also requires insurers to publish the latest NAV per unit of each fund on their website every day.

• Under single pricing, there is no bid-offer spread.
• Units are created, purchased, valued, and redeemed at a single, uniform price: the Net Asset Value (NAV) per unit.
• Instead of an embedded spread, distribution and acquisition costs are disclosed through the unallocated premium schedule and the explicit charges.

Net Asset Value (NAV) Calculation Mechanics

The Net Asset Value represents the fair market worth of one unit in an investment fund. The valuation is performed daily at the close of trading on Bursa Malaysia and international financial exchanges.

$$\text{NAV per Unit} = \frac{\text{Market Value of Fund Assets} - \text{Fund Liabilities and Accrued Expenses}}{\text{Total Number of Units in Issue}}$$

Worked PCEIA Calculation (NAV and Unit Transactions): Dana Amanah Ekuiti holds investments in Malaysian blue-chip equities and short-term deposits valued at RM 245,000,000 at the close of business. Accrued fund management fees, audit fees, and custodian expenses total RM 5,000,000. There are currently 200,000,000 units in issue.

• Net Fund Value: $\text{Net Fund Value} = \text{RM } 245,000,000 - \text{RM } 5,000,000 = \text{RM } 240,000,000$
• NAV per Unit: $\text{NAV per Unit} = \frac{\text{RM } 240,000,000}{200,000,000\text{ units}} = \text{RM } 1.2000\text{ per unit}$

Transaction 1: Purchasing Units from Premium Allocation Encik Firdaus pays a monthly premium of RM 300, of which 90% is allocated to Dana Amanah Ekuiti. The allocated premium is RM 270 ($\text{RM } 300 \times 0.90$).

• Units Purchased: $\text{Units Purchased} = \frac{\text{Allocated Premium}}{\text{NAV per Unit}} = \frac{\text{RM } 270}{\text{RM } 1.2000} = 225.00\text{ units}$

Transaction 2: Monthly Unit Cancellation for Mortality & Admin Charges On the monthly policy anniversary, Encik Firdaus's policy incurs a mortality charge of RM 42.00 and a policy administration fee of RM 6.00 (total monthly deduction = RM 48.00). Assuming the NAV remains at RM 1.2000:

• Units Cancelled: $\text{Units Cancelled} = \frac{\text{Total Monthly Charges}}{\text{NAV per Unit}} = \frac{\text{RM } 48.00}{\text{RM } 1.2000} = 40.00\text{ units}$

The insurer cancels 40 units from Encik Firdaus's account, leaving him with a net addition of 185 units for the month.

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Investment-Linked Fund Types and Asset Allocation Matrix

Insurers offer policyholders a menu of internal investment-linked funds catering to diverse risk tolerances and investment horizons:

1. Equity / Growth Funds: Invest primarily, in accordance with the disclosed fund mandate in common shares listed on Bursa Malaysia and approved foreign bourses. Characterized by high price volatility, high capital growth potential, and sensitivity to macroeconomic cycles. Target profile: Young to middle-aged policyholders with aggressive risk appetites and horizons exceeding 10 years.
2. Fixed Income / Bond Funds: Invest primarily in Malaysian Government Securities (MGS), Bank Negara Monetary Notes, high-grade corporate bonds, and institutional debentures. Characterized by regular coupon generation, low-to-moderate volatility, and steady capital preservation. Target profile: Conservative investors and retirees.
3. Balanced Funds: Maintain a blended asset allocation—typically 50% to 60% equities and 40% to 50% fixed income instruments. Designed to capture equity growth while cushioning downturns through fixed income yield. Target profile: Moderate risk investors.
4. Money Market / Cash Funds: Invest in short-term bank commercial deposits, Treasury bills, and negotiable instruments of deposit (NIDs) with maturities under 12 months. Characterized by virtually zero market risk and high liquidity, but low yields that may trail inflation. Target profile: Short-term capital parking or extreme risk aversion.

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Operational Facilities and Critical Policyholder Risks

ILPs provide superior operational flexibility compared to traditional contracts, but this flexibility introduces significant consumer risks.

Key Operational Privileges

• Ad-Hoc and Regular Top-Ups: Policyholders can accelerate wealth accumulation by injecting surplus cash into their unit account at any time, subject to a minimum sum (e.g., RM 500) and deduction of the top-up fee.
• Partial Withdrawals: A policyholder can liquidate a portion of their accumulated units for immediate cash without surrendering or terminating the policy. Insurers require a minimum remaining balance (e.g., RM 1,000) to ensure sufficient units remain to fund ongoing monthly mortality charges.
• Fund Switching: Investors can rebalance their portfolio dynamically between equity, balanced, and bond funds in response to changing economic outlooks or lifecycle stages.

The Premium Holiday and the Risk of Policy Lapse

A premium holiday is a contractual feature permitting the policyholder to temporarily stop paying regular premiums after the policy has built sufficient unit value (typically after 1 to 2 years), while keeping insurance coverage intact.

No Guaranteed Cash Value: Investment Risk Allocation

In strict contrast to traditional non-participating or participating life policies, an ILP carries zero guaranteed cash surrender value. The entire investment risk—both the upside opportunity and the downside capital loss—is borne 100% by the policyholder. Neither the life insurer, nor Bank Negara Malaysia, nor the Malaysian government guarantees the capital value or return of an investment-linked fund.