Unit Linked Insurance Plans are a hybrid type of insurance product which tries to combine insurance and investment in securities. A conventional insurance product is a term insurance which provides a cover against loss. A good example is your vehicle insurance where the insurance company has to pay you only if your vehicle is involved in an accident. A term life insurance product operates in the same principle where the payment is due only on the death of the policy holder. A lot of people feel that the premium they pay for this protection ‘goes waste’ and they do not get any return on those premiums. But the point is that the premiums you pay, is a guarantee against unforeseen risk.
Insurance companies brought out ULIPs to take part in the bourgeoning stock markets and to provide an ‘investment + insurance’ instrument. And several people think they are getting the best of the both worlds and end up investing in a ULIP. ULIPs are characterized by high entry charges, as much as 25% of your first year premium and offer attractive commissions to their agents (advisors), who often mis-sell this product.
Several agents sell a ULIP by comparing it to mutual funds and if you point out better performing fund, the agents say that there is an insurance cover attached. However this ‘insurance + investment’ product serves neither of the two objectives properly! Neither does it provide a large insurance cover nor does it give returns as attractive as a mutual fund due its high operational charges. I shall list the charges of a popular ULIP in the market:
- 15% premium allocation charge in year 1
- 5% premium allocation charges for years 2- 4
- Admin charges Rs 60 per month as long as you hold this policy
- For the first 3 years annual administration charges of Rs 5 per 1000 of sum assured
- Fund Management charges of 1.5% per annum
- Mortality charges which are levied on the first day of each policy month
I doubt if your agent would give you all this information at the time of selling you a ULIP!
However you can also see that most of the charges are concentrated towards the first few years and after 4 years the charges of a ULIP drop considerably and they give a much better return. Due to the long term nature of the product, the ULIP fund manager is able to make investments with a long term perspective and hence the fund usually provides good returns if you look at a 10 year horizon.
A few misconceptions that people have and something I would like to clear are:
1. A ULIP is not a Mutual Fund
Your agent would try to position a ULIP almost like a mutual fund, but a ULIP is an insurance product which invests your premium (after deducting certain charges) in securities. The charges of a ULIP are much higher than a mutual fund and if your objective is only to see a good return on your invested money, then DO NOT go for ULIPs.
2. A ULIP is not better than term insurance if your objective is protection and life cover
A term insurance product will give you much higher life coverage for the same amount of premium. Do not take a ULIP if you are only looking to cover your life against unforeseen risks.
3. Insurance vs Investment
Bothe insurance and investment are two basic blocks of wealth planning and both are necessary but do not confuse between the two and do not try to mix up the two. Insurance aims at providing protection against risk and a product which tries to combine both, at best does a mediocre job of both.
When does buying a ULIP make sense?
If you are planning to systematically invest for a time horizon of over 8 – 10 years for a long term objective (like your child’s education), then a ULIP may make sense. I have seen a few products which are structured well enough to provide a child a fixed amount at the time the child turns 18 even if the parent passes away before making all the premium payments and in case the parent outlives the policy period, the child still gets the invested amount. However if you are a savvy investor, you can even get a better deal by carefully choosing a combination of a term insurance (for insurance cover) and a basket of mutual funds.
I would like to conclude by stating that if you want insurance and equity investments; buy a term insurance plan and a mutual fund separately. If you do want to buy a ULIP or have already bought one, then hold on to it for at least 8 – 10 years, unless of course you have a need for money or think that you can invest somewhere else for a much higher return.