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Why ulip?
Unit-linked insurance plans (ULIPs) have become quite popular of late with the investors. A substantial part of incremental growth of life insurance companies is coming from these products. This clearly highlights that investors have accepted it as a good and strong medium of investment for both their life insurance and fund creation needs. Another reason for these plans gaining popularity are the flexibility they offer to the policyholder in choosing the investment pattern along, life insurance risk cover & the transparency with regard to charges.
Most ULIP’s offer an opportunity of diverse funds that can be broadly classified as:
Aggressive – These typically invest 80 per cent-100 per cent in equities
Balanced ULIPs – These invest around 40 per cent-60 per cent in equities
Conservative ULIPs – These invest up to 20 per cent in equities
There is also an option of pure debt funds.
ULIPs are useful for those who want to be insured but at the same time are interested in investing in an avenue, which matches their risk-return profile. ULIPs are better suited for people who have a conceptual understanding of financial markets and are genuinely looking for a flexible, long-term investment–cum- life insurance.
ULIPs are generally long term in nature ranging anywhere between 5 years to whole of life. Over a longer horizon, ULIPs are expected to provide both positive and attractive returns. In addition, being life insurance, they also provide tax benefits on both invested premium & the fund value on exit.
Modern customers are increasingly looking for a single window service. A single transaction from the customer’s viewpoint is always easier than multiple transactions, required in the case of segregation of life insurance needs from investment needs. This also calls for the customers to give more time to his investment decision and ULIP reduces this time.
Advantages
One big advantage that ULIP provides is a complete selection of high risk, medium risk and low risk investment options under the same policy, which a client can choose from based on his/her risk taking appetite coupled with the opportunity that will enable him/her to switch between fund options, generally up to 4 times a year at no additional cost.
ULIP is an outstanding solution for risk cover, long term investments with the benefit of various investment opportunities all at one place coupled with tax benefits.
ULIPs provide consumers with the best of both worlds – insurance and investment. The first and foremost purpose of insurance is and will always be risk cover. . As an instrument of risk cover, insurance provides benefits that no investment can offer. It is important for an investor to understand his financial goals and horizon of investment in order to make an informed investment decision.
It has become very common to see advertisements of unit-linked insurance policies (ULIPs), which are being touted as products which provide the best of both worlds - investment and insurance. Investors are lapping up these products, without knowing the fact that a better and far superior alternative to ULIPs, exists called term insurance, which is seldom advertised.
However, term insurance combined with investment in diversified mutual funds through the systematic investment plan (SIP) route, would give you better risk cover and returns.
You can break up your investment into two parts: Suppose Mr A, aged 30, pays an annual premium of Rs.1 lakh on an ULIP with other investments equity funds. Instead, he buys a term policy and invests the balance in diversified mutual funds. Let us understand how this works:
ULIP’s offer a risk cover of 5 to 40 times the annual premium. If we were to take the highest risk cover available, it is Rs 40 lakh. In a term policy , the premium would work out to approximately Rs 14, 900 per annum. That leaves Mr A with Rs 85,100, which he invests in diversified mutual funds, which generally invest his money after deducting an entry load of 2.25 per cent. This investment compounds at a very modest growth rate of 10 per cent annually would amount to approximately Rs 1.5 crore after 30 years.
The same money, if invested through a ULIP, would yield approximately Rs 1.32 crore after 30 years. That is a loss of Rs.18 lakh to the investor! The reason for this is that insurance companies have very low allocation rates in the initial years. This means that a large part of your premium is deducted for marketing expenses, agent’s commission, mortality charges etc.This brings down the yield considerably.
Another interesting point is that most ULIPs are sold with the investors being told that they can opt to discontinue paying the premium after 3 years of continuous payment and the policy will remain in force. The disadvantage to this is a drastic reduction in their risk cover as soon as the premiums stop.
Let us also observe a scenario, where premiums are continuously paid and Mr A unfortunately passes away after 20 years. The total death benefit on his ULIP would be around Rs 44 lakh, since ULIPs give a death benefit of sum assured or fund value, whichever is higher. In this case fund value is higher. In the other option, the fund value would be approximately Rs 52 lakh. Over and above this his nominees would get Rs 40 lakh on his term insurance policy, which gives a total death benefit of approximately Rs 92 lakh.
ULIPs may argue that they offer a choice of various funds from equity to balanced to pure debt, but the same option is available with mutual funds. Even the free switches between funds does not help as trying to time the market is very difficult for experts, let alone a lay investor. While the single window bundled offer of insurance with investment that they offer is good, but not at the cost of losing out on so much as you have seen above.