About ILP (Investment Linked Policy)

A question that I posted on the fundsupermart.com forum.
I though the answer is beneficial to those who are going to buy some form of insurance or do some form of investments

My Question
With regards to ILP, I had a question in mind; I heard that for ILP the premiums are invested into unit trusts and insurance charge are paid via the sales of the units - the highlight - what happens when your premium exceeds the units you had?
Do the insurance company charge
a) Difference between the premium you paid / units left and the insurance charge OR
b) All insurance charge are capped at the premium you pay?

Doesn't seemed to be the correct place to ask, but I think it's an important question.

Reply:
Hi All,

I have a huge ILP from AIA. When I purchased it, I was new to investment and didn't even know what a Unit Trust was. That was back in 1999. I am okay with an ILP concept but to be honest I am not impressed with the commission charges that are usually prevalent of in such ILP policies is ridulous. Off memory, I only had 20% of my $600 monthly premium going towards purchasing Units, and 80% to the sales person and other admin charges. However, I think new ILPs may have improved since so no need to totally discount them.

In answer to the above points:
(A) The way a typical ILP works is this. Let's say you insure yourself for $500,000. Premium is $500 / mth. On the 1st month, you pay your premium, and we pretend out of the $500, $100 goes to misc charges (includes commission, etc), and all $400 goes to purchase of Unit Trust. Then on a monthly basis, a deduction is made from the $400 of units purchased, for payment of the insurance premium, eg., 2 units pay for death insurance, 5 units for critical illness. Thus your guaranteed insuance amount if $500,000. The non-guaranteed is the units in the Unit trust that has been invested net of cost of insurance ie., the $400 - deducted unit amount. This $400 will change based on the performance of the Unit trust it is invested in. Hence over time, over many years, your insurance will 'grow' in value via guaranteed insurance payout due to death, etc of $500,000 and the non-guarantee amount $$ of your unit trust. Non-guarantee is definite payment but the amount if non-guaranteed.
(B) insurance charges are capped is a bit misleading. You pay a fixed amount say $500 / mth for the next 40 years. However, the insurance charges which are deducted from your units can increase over time. For example, my critical illness charges increase with my age, and this is defined in my policy booklet.

The problem with all the misunderstanding is I feel insurance people do not tell you the real model and they paint it as fixed $ payment over 40 years. My AIA guy actually told me that my $600 / mth payment gets cheaper as value of $ decrease over time due to inflation. He failed to tell me the increase of charge.