ULIP - Unit Linked Insurance Plan
An opaque form of investment, that's costly for you, and doesn't adequately cover you. More importantly, you cannot exit if you choose to, not until maturity.
This is a single instrument / vehicle which gives Insurance and Investments. It uses the income tax laws to provide tax-free returns(most of them do, but changing laws sometimes changes the status of such plans – so always do check the actual laws and the relevance of the particular Ulip).
In other words, Ulip is a type of mutual fund (in the sense that they get your money, convert them into units and professionally manage the money while charging you a management fee) which uses the tax laws to make the entire instrument tax free or as tax-friendly as possible.
- 1.The insurance component: Usually it is kept to a minimum. Prior to 2-3 years, most of the Ulips had a minimum of 5x premium of insurance cover. Why? Because the tax laws then said that for any insurance plan to get included in 80C section, it had to have a premium of <20% of the insurance cover. eg. If the plan had to have a cover of 1 lakh, then the premium should be less than 20k. Then this limit was changed to 10x (=max. 10k premium for 1 lakh cover). However, you need to remember that the insurance cover provided is 10x on the lower side. On the higher side, it can be 20-30x also. There will be proportional increase in the Mortality Charges too. Compare this with the amount of cover which an online policy can give – around 1000x.
- 2.The Investment Component: The money which remains after deduction of the various charges is put into one of the fund(s) allowed in the particular fund of that company. Then that money behaves like being in a mutual fund (gives the name Unit-Linked).
- 1.Mortality Charges- Since this is an Insurance policy, there are mortality charges which are deducted usually every month (not quarterly or yearly). Usually, it is done in terms of Total Cover – Fund Value and the relevant mortality rate is applied. Eg. For a male of 30 years, if the cover is of 10lakhs, while the fund value of the policy is 2 lakh, the rest 8 lakh cover incurs the mortality rate of 1.91 per thousand which means an yearly premium of 1,528 (or 127 per month) plus service tax (12.36%). If the fund value is 6lakh, the mortality rate will be 764 per annum. Only when the fund value is more than the Cover, the mortality charge becomes Nil. The charge is applied by removing the corresponding amount of Units from your total fund units.
- 2.Premium Allocation Charges- This is a variable rate and is mostly related to the Commission to the Insurance Agent. However, on the lower side, it is @ 2% while some years back it used to be 50-70% in the first year, then 20-30% in second year. Usually it is there in the first 5 years (basically the absolute or relative lock in periods). Prior to Sep 1, 2010, the Ulip structures were for 3 year lock in, so the major premium allocation charges were in those 3 years. Later on, the 5 year lock in was put, so the Ulips were redesigned to distribute the charges accordingly. Even the Top Up premiums undergo this charge but usually to a lesser amount. This amount never goes into Insurance or Investment at all.
- 3.Policy Administration Charges- The company charges you this amount to send you monthly statements. It is set to increase yearly and is applied by removing units.
- 4.Fund Management Charges- This is the actual professional management fees of the funds, and they are charged, like any other Mutual Fund, by daily deduction from the NAV of the fund itself. They are usually fixed but canbe increased by the company by intimating it to you.
- 5.Surrender charge- Currently, if you want to surrender your policy in the first 5 years, then it is called Discontinuance and after deduction of charge (range of 2-6%), the remaining amount is transferred to a discontinued policy fund (where it earns 3.5% return, mostly with some kind of fund management charge) and the final amount is given to you at the end of 5 years. If you surrender the policy after 5 years, then after appropriate surrender charges, the policy is terminated and the fund value is provided to you. For Older Ulip policies, similar terms particular to that policy apply.
- 6.Rider Charges- If the policy has riders like accidental death rider, critical illness rider, etc, then the appropriate amount of those charges are levied by cancellation of units.
- 7.Guarantee Option- Some policies use Guarantee option in providing some sort of guaranteed return. Usually such options are completely debt based options and do incur an additional guarantee charge over and above all the other charges.
In short, any type of benefit is charged accordingly, and nothing is free. The only major difference from the other traditional insurance policies is that everything is clear and written in Ulips while it is not so in those.
- 1.Top Up: Over and above the normal insurance premia, you can put extra amount of money as Top Up Premium. This now requires you to have additional corresponding amount of insurance (in the older Ulips, the additional insurance cover was not mandatory). Eg. If by 10k premium you get 1 lakh, an additional 10k top up premium can get you an additional cover which can be variable (eg from 1.1x to 5x to 10x). The other difference is that the Premium Allocation Charge is usually lesser than the normal premium. However, in the newer policies, the top up will have a lock-in of 5 years from the date of the top-up.
- 2.Switching: Out of the various fund options available in a policy (some have 5, some have 7, etc), you can allocate the entire money in a liquid fund, or a longer term debt fund, a large cap type of fund, mid cap or multi-cap, etc. In general, out of the various options, you can allocate your fund money in parts or in total to 1 or more funds of that policy. Some policies have Automatic Switching options in which according to age, the percentage of equity-debt will change or according to an increase in decrease in the fund allocations, an appropriate automatic change will occur. Mostly, such additional options do incur charges but this also depends on the policy.
- 3.Premium Paying Term (PPT): This is the period for which you will pay regular premiums. Usually the minimum is 5 years (in older policies, it was 3 years). However, there are single premium payment policies too. This option appears to be very confusing to many people. If someone opts for a 5 year premium paying term, he/she will be able to regularly pay premium for 5 years, and then depending upon the duration of the policy, after various charges, the net fund value will be given back to the holder at the end of the policy period. Eg, if the premium is 10k yearly for a policy with PPT of 5 years and total policy duration of 10 years, the valuation of those 50k after various charges will be given back at the end of 10 years. It DOES NOT mean that for the empty 5 years from 6-10 years, the company will pay it. Compare this with the same policy with PPT of 10 years and period of 10 years. The fund value will be more than the first example policy.
- 4.The PPT, the frequency of paying premium and the Sum Assured are all usually kept flexible and can be changed.
- 5.After a specific time frame (mostly 5 years), there is option for Partial Withdrawal of your money from the fund. It behaves like Partial Surrender.
The insurance risk part is borne by the company and the Mortality Charges are accordingly set. In this way, this part is not different from the plain vanilla term insurance.
The investment risk part is completely the responsibility of the policy holder. This is the same as in any Mutual Fund.
For Ulips, there are usually no Revival options. If the policy is discontinued or foreclosed, then the appropriate option is followed automatically. Compare this with traditional policies, in which a policy can be revived later too.
What is BAD about Ulips?
Firstly, Insurance is an expense and by combining it with a savings/investment option, the purpose of the entire instrument becomes kind of tug of war between two different aims. The primary way should be to check the eligibility and requirement of the life insurance for the person which includes:
(I) Whether life insurance is required or not? If there are no financially dependent persons, life insurance is not required.
The 10-30/40 times premium Sum Assured FOCUSES on the amount of premium which you can pay rather than the primary aim of The Total Sum Assured (Life cover amount). Eg. For a 30 year old male, the online plans give a sum assured of approx. 1000 times yearly premium. For offline the corresponding value is anywhere between 500-700. At higher age groups and with large term periods, there is corresponding lowering of the sum assured.
In short, the insurance component of a Ulip is 99% of times inadequate as a sole policy.
Secondly, the mortality charge table used in Ulips is higher as compared to mortality charge table for the same company in its own non-ulip term (offline / online) policies. In general, the inadequate insurance cover is expensive too.
Part 1: CHARGES
- 1.The Premium Allocation Charge is a front-loading charge, which means the charge is levied first and then the rest of the money is put for investment. Compare this with ongoing charges like Fund Management Charges or Back-loading (eg Exit loads in which the charge is levied at the time of withdrawal). In older times, when there was an Entry Load on the General Mutual Funds, which now is not present. This charge as mentioned is basically a commission charge for the agent and/or company, and does not help the investment in any manner.
- 2.Policy Admin Charge- completely useless charge. Everything can be seen online and this charge is waste of money. Over that, this charge usually increases year on year.
- 3.Surrender / Discontinuance Charges. This is the back-end load and decreases the liquidity of the money.
Part 2: FUND MANAGEMENT
In older times, the insurance companies used to delegate the responsibility of fund management to the regular mutual fund companies and did not require a separate fund management team. Now they are required to do so. In most companies, the size of the investment team is small (sometimes even 1 or 2 main persons managing the various funds). The quality of fund management in insurance companies is thus lower than that of the regular MF companies. The 1.35 -1.5% FMC (adding service tax of 12.36% means this gets translated to 1.5-1.7% net) of most equity funds in the various Ulips is comparable with the charges in the Direct Plans of the regular equity mutual funds. Similar is the case with the debt mutual funds. If you will look in more detail, then presently the FMC of equity and longer debt Ulip funds is in general slightly lower than corresponding regular funds, while those of liquid/shorter term debt ulip funds is slightly higher.
As far as I know, simple index funds are not available in any of the Ulips (I have checked the insurance fund section of Morningstar.in and have not found any index fund). For some people, this is a very decent option with minimum charges (but then, Ulips are not cost-effective at all).
Part 3: The Various OPTIONS-
This is touted as a major benefit of Ulips. The ability to move money from equity to debt at market tops, and then move money from debt to equity at market bottoms is extremely beneficial. The only problem with that is no one has been able to do that consistently ever (at least that is what all the major gurus say in the world all these years). Moreover, market tops and bottoms are only apparent in the hindsight and not when they are occuring. So, if all the smart people have never been able to do that consistently, how can that be expected from a relatively unknowledgeable / less knowledgeable person buying a Ulip. It may be helpful for a very select few, but not for the 99.9% people. Also, behavioral finance tells us that if given an option like that, most people would do it in reverse, that is put money into equities near tops and put money into debt near bottoms. This is even worse than not doing anything at all.
Part 4: ILLIQUIDITY and LOCK-IN
If the management team of a regular mutual fund is not performing to your satisfaction, you can remove your money from them and put that amount into a different company. OR you can remove your money within the fund company. In Ulips, neither you can change the fund management company nor you can transfer away from funds available in your particular Ulip to another fund within the same company.
The surrender / discontinuance charges are extremely high. Compare this with 1-3% exit loads in various regular mutual funds.
The Illiquidity costs in a Ulip are very high WITHOUT providing a corresponding degree of benefit.
- 1.Too many charges. = Expensive and Complex.
- 2.Not-so-great management teams as compared to regular Fund Companies. = Suboptimal Management with comparable management expenses.
- 3.Very Illiquid, without providing any corresponding benefit for that illiquidity.
- 4.Insurance Benefit is too low for use and expensive as compared to a comparable term insurance.
- 5.Complex Options which in general are worse.
What is GOOD about Ulips (=Pros)?
Ulip is probably the perfect option for those people who get utterly confused and get policy-paralysis or decision paralysis (No, this is not an uncommon thing. More and more options, after all there are thousands of mutual funds in India, just create a severe type of confusion and to prevent selection of a bad or suboptimal option, one just does not choose any).
The advantages of Ulips are:
- 1.They give you an equity based tax-free option in the 80C category. The other pure equity based option is ELSS (Equity Linked Savings Scheme). While private pension plans (like Templeton India Pension Plan and UTI Retirement Benefit Pension Plan) are hybrid debt oriented mutual funds with decent options) are also there. In case, ELSS get dropped in DTC, then these will remain as the only pure equity based plans (of course, one can choose an 80% or 50% equity option too).
- 2.Although, the insurance component is inadequate in these, but as an asset allocation instrument (and NOT as a market timing instrument), this provides free transfer from equity to debt or vice versa. Free both in the sense of a number of switches every year as well as no payment is required in terms of capital gains tax as would happen if this is done outside between mutual funds or direct stocks, debt instruments, gold and cash.
- 3.The trigger portfolio option and automatic life-cycle based asset allocation are decent options for people who do not have the know-how or emotional execution capability.
- 4.The loyalty addition is a small bonus if the requirements are fulfilled diligently.
In short, presently Ulips are mostly good in terms of behavioral financial aspects.