5 REASONS FOR AVOIDING ULIP
Unit Linked Insurance Policy (ULIP) have been around for many years now and they grew in popularity ever since it’s launch. Generally we get the sale calls from agents in banks and insurance companies around the tax season, urging us to invest in ULIPs for tax benefits, guaranteed returns, etc., but as it is a few months away I thought it is a good time to make an evaluation.
ULIP is a combination of life insurance and mutual fund and was quite an innovation when it was first introduced. It gave flexibility for the first time to the investor as he/she could decide on the premiums and the funds to invest in. But such innovations never came without a price, as the costs involved were considerable. These costs included Premium Allocation Charges, Mortality Charges, Fund Management Fees, Policy and Administration Charges, Surrender Charges, Fund Switching Charges, Service Tax Deductions, etc. I wouldn’t go over to explaining all the charges here ( if you want me to explain these charges, just ask in the comments), but as you can see it is quite a long list. The result of all these charges is that, the premium that is being paid by the investor is actually shrunk by almost 40%, it varies from product-to-product off-course, and only the balance is invested into the fund. Most of the insurers and their agents argue the fact that these charges are high only in the first few years and gets even out in the long-run. Now how it gets “even out” is mainly because of the returns projected. So now let us take a look at the returns from a ULIP.
For the last few years we have come to see that the sales call is coining a new term called “guaranteed returns”. Now what the heck can be guaranteed when there is no such thing as a “guarantee” in the financial markets? To find an answer to the question, we have to dig a bit more. Well as I wrote that a ULIP is like a mutual fund, there is a NAV in it. Now some of the ULIPs have introduced a method of giving the return after the plan terminates, on the highest NAV achieved during the tenure of the plan. Click here for an explanation of How do Highest NAV Guarantee Plans work. In short the insurers’ switches their investment from the equity portion of the fund to the debt portion of the fund to maintain the returns of the highest NAV achieved during the tenure of the fund. Now, the returns of these “guaranteed returns” ULIPs will be no better than that of the debt instruments as the fund switches it’s investments to the debt instruments all the time. Hence these ULIPs will give a return of no higher than 7%, as is the returns of a common debt instrument. Moreover, as a ULIP is directly linked with the financial markets, the returns can never be guaranteed.
Now I present to you my top 5 reasons for avoiding a ULIP plan. Here it is:
- Expensive: With a plethora of charges as mentioned above, ULIPs are a very costly insurance product.
- Partial Investment: If you want your money to be invested in full into an investment, ULIP may disappoint you, as a considerable portion may be cut-off towards charges and risk cover.
- Returns Not Guaranteed: This is understandable as the product is linked to the capital markets. As such the returns may not be what the fanciful graphs and charts suggest. This is also been confirmed here http://www.livemint.com/2011/07/17210717/Mutual-fund–term-insurance.html.
- Not Profitable In The Short-Term: While returns are not guaranteed at all, ULIPs are also not profitable generally in the short-term, unlike equities or mutual funds. This is because of the high costs involved. So without keeping a view of staying invested for at least 10 years, profitability from ULIPs is remote.
- Financial Expertise Required: One must have the expertise to manage an ULIP. These are not invest-and-forget schemes. To derive the full potential from ULIPs, one must know when to switch between funds or come out of it. This also requires active monitoring of the funds, which may be quite disadvantageous for a busy person.
As you can see now, that ULIPs are not the right option for a savvy investor. If an insurance agent is trying to sell you such products, do know that there is a high commission on offer to sell these products. Although I feel that there is nothing wrong in getting a high commission, the product should be good too. The other reason why the insurers would like to sell you a ULIP is because the risk is borne by you and not them, unlike a pure insurance product where the entire assured amount is at their risk.
So stay away from it and know that there are other ways to save taxes than investing in an ULIP.
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Point 5] This is the only point I agree with. Having said that, if one maintains a portfolio of stocks or Equity funds — that also requires continous monitoring. Bottomline — how much time and expertise you invest in products like ULIP, MF , Equity – only then you can reap the benefits. The major drawback in ULIPs is the way they are 'SOLD' by the agents as short term or guaranteed return products – which they are not. The Mis-selling of ULIPs is the most negative aspect about these products. SUMMARY : Anyone who does a writeup on whether ULIPs are good or bad — Please consider all points and at the same platform. Donot avoid certain criterias just to prove your point. Your Reasons for not selecting ULIPs are very vague as they are not compared to exact combinations. However, they do highlight in a way the gimmics that agents play to sell Ulips. >>>> Are there better options than Ulips — Definitely Yes !!! The MF + Term Insurance may work out the better than ULIps — but discard ULIps for the correct reasons and not the vague points or incomplete comparisons made in the article.
Well, as I have said in my earlier replies that this article didn't tried to compare ULIPs with anything else. I feel that ULIPs are not good investments whether you want insurance or long-term/ short-term returns. Even if you have a higher risk-appetite than others, ULIPs are best avoided because it lacks in flexibility as your investments are locked for 3 – 5 years and you cannot get out. I don't know how clear I can be in stating my observations on the features of ULIPs in general, but if you think it's still "vague", then perhaps you should point me or my readers to some real-life examples and articles elsewhere, that have a different viewpoint.
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CONCLUSION : 1] Since ULIP are combo products — any statement that you make …. you need to do in the light or or in comparison to other insurance or investment products or combo of investment products (eg: MF+PPF). 2] Secondly, since ULIP are not short term products (its unfortunate that they are mis-sold that way), dont highlight there negative features in short term. 3] Considering ULIP as long term products — they are more flexible than any other combinations(switching in , switch out). 4]Also they offer new inuative products/features (I am not talking about the so called 'Guaranteed Products' – which are mis-sold) – ATP, Trigger Based fortfolio, LifeCycle based portfolio, Dynamic P/E based fund —- these in principle are good — but only time will tell. But on the face — giving more options.
We mutually agree to many of the points — but how we place that point is also very important.
Bottomline : ULIP are not pure investment products and neither short term — SO PROBLEM LIES in the fact that people are buying ULIP for short term investments – which is wrong. In the long term, MF + Term Insurance would most probably outrun ULIP. But the reduction in costs in ULIPs, addition of new features and the added flexibility makes it a tight contest. Most stable cost effective insurance-guaranteed return investment product with same tax advantages as an ULIP is PPF+Online Term Insurance. Dont mix investment with insurance — is what many people say. I agree to a certain extent with that, but having said — if you have already invested in ULIP – dont discard it just as it is — try to make the most of the features/flexibility in it. If you havent invested in ULIP — still consider it, know its features — you might come across a product which is reallly great or a winner. One such product was ICICI Prudential – ACE policy — no longer available — read it and find if any MF can match it as a pure investment product
Okay, here are my answers to your next round of criticisms:
1.YOUR COMMENTS: "let me give you further explaination / tips…. whenever you make any statement regarding one product is Expensive or one product is illiquid — then you have to do so in the light of other products or compare it to other products — to make the reasoning or statement more effective."
MY ANSWER: Yes, I agree that a comparison between two or more products would have been more effective in my reasoning. So, thanks for your tip.
2.YOUR COMMENTS: "What oppurtunity costs & what flexibility…..there are so many features – SIP, ATP (Automatic Transfer from Debt to Equity – Twin advantage of SIP and some money always giving returns in Debt — Better than lumpsome investment or SIP alone). Lifecyle Portfolio , Trigger based portfolio, Dynamic P/E funds"
MY ANSWER: Opportunity costs are the cost you pay when you miss another good opportunity to earn more. If I see that the long-term returns from ULIPs are less than another long-term instrument, I've lost the opportunity of earning from that instrument as I invested in the less-earning instrument. By staying invested for 5 years in an ULIP,in it's new avatar, I may loose the opportunity of earning from some other instrument, which has guaranteed returns in 5-years, say NSC or a Fixed Deposit. I was not writting about flexibility in swiching between funds in an ULIP, but was looking at the flexibility of comming out of an ULIP, if I want to get out of it; which ULIPs don't have. The SIP, ATP, etc. that you have mentioned are different investment strategies employed, but that is not what flexibility in an investment is all about. The average investor would ask, "what would happen if my money is not earning anything for me? Can I get out?".
3.YOUR COMMENTS: "When Insurance can never be short term, then how can a product which is a combination of Insurance and investment be short term."
MY ANSWER: Is it not more wise to keep insurance and investment seperate then?
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Now, I would like to summarize your views, for the benefit of the readers of the blog and also for you. Here are your views:
1. ULIPs are long term products and never to be taken as a short-term investment vehicle.
2. They are flexible as an investor can switch between funds and employ SIP, STP,Lifecycle Portfolio, etc.
3. ULIPs are not expensive products.
4. I should always try and compare between investment products when writting an article.
And here are the synopsis of my views:
1.ULIPs are risky investment vehicle and will only suit those who have a higher risk-apetite than others.If someone thinks that ULIPs may be successful in delivering returns over the long-term only, there are better investment avenues for long-term savings, e.g. real estate, gold,PPF,etc.
2. Flexibility and liquidity goes hand-in-hand. Long lock-in periods of 5 years is no incentive to invest in a scheme for sure. If a financial crisis arrives within 5 years, one cannot touch his own money.Flexibility to switch between funds or having a different investment strategy is not good enough a option for being successful in the long-run. One can employ a different investment strategy and choose a different fund, yet get a poor return. When there's a fire in the house,the priority is to save the valuables and life, that is what is left of them and to get out, not staying-in and putting up a fight against the fire by different tricks/strategies.
3. Have a look at these links for a better understanding and form your own views –
http://info.akosha.com/consumer-complaints/fortni…
http://businesstoday.intoday.in/story/mutual-fund…
http://www.moneycontrol.com/news/mf-experts/term-…
http://www.simpletaxindia.net/2012/03/ulip-expens…
http://wiki.answers.com/Q/Comparison_between_mutu…
http://eminentmoney.blogspot.in/2012/03/ulip-is-b…
4. This blog is about making sensible investment decisions for optimum returns and prosperity. So,if you want me to write in a different way, no issues, I will try and write more comparison articles in future; point noted.
And now, let me ask to the rest of the readers of the blog – What are your views? Do you agree with my views on ULIP or to that of Amit Rastogi?
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Point 3] Returns are not guaranteed — whoever said that ULIP give Guaranteed Returns – they dont claim that. Even a Mutual Fund does not give guaranteed returs – as both are linked to Capital Markets – even you say so. ULIP do have Guaranteed NAV products, but that is another story — as they work differently and need to viewed in a different light. Point 4] Not Profitable In The Short-Term —- Whoever said that ULIP are short term ??? Insurance can never be short termed. They should be considered with a long term view only. Another point I would like to make, if one continues MF and other one has ULIP – then the charges of MF takeover the charges of ULIP in the 10th yr onwards. The LIVE MINT article has conveniently selected 1.75% FMC, while for equity funds it differs from 1.5 to 2.5 with many having more than 2.25%. For ULIP FMC charge has been capped at 1.35% and not 2.25%. Other charges are there ofcourse. Mortility Charge will be there even for a Term Insurance (which the Livemint has taken into consideration – Insurance + TI).
There are different ULIPs in the market today from different companies. Some of them have a "guaranteed returns" feature and that's what I tried to highlight in my article above. I have not written that all the ULIPs for all the companies in the market have "guaranteed returns" feature. I have also tried to highlight the investment aspect of an ULIP, as ULIP is a combination of both investment and insurance. I feel your investment should be as liquid as possible, depending on your overall financial plan. I will never advocate the idea that your investment will always be for the long-term, because depending on your need and goals in life, it not necessarily have to be so. If someone invests in ULIP for the sole benefit of long-term returns and also insurance, the first thing that one should comparre it with is with a safe long-term investment product, e.g. PPF. If it beats the returns and the time-frame of that long-term investment product, then only he/she should try and go for that alternative. By being "Not Profitable In The Short-Term", I was trying to highlight the lock-in period that all ULIPs have, which is 3 – 5 years. If someone thinks that he wants to get out after that, whether it will be profitable or not; that was my intention.
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Point 1 ] Expensive. In ULIP – all charges are transparent. And if you compare it with traditional plans — traditional plans charges are not transparent and are way higher (check with old LIC agents to get the real picture). Also with IRDA using strict guidelines – ULIP charges have gone way down as compared to some 4-5 yrs back. Point 2] Its obvious that the investment amount will be partial — Insurance does not come free. Unless one goes with SIP Insurance, but that has some reservations – thats another story. Again , are you comparing ULIP with a Mutual fund or any other investment. Then the comparison itself is incorrect as ULIP should not be considered only as a pure Investment product – becuase its not.
Yes, I agree that charges have come down, but the lock-in period has gone up too. The lock-in period used to be 3 years, but now it has gone up to 5 years. So, it used to be expensive because of the charges and now it is expensive because of the opportunity costs and lacks in flexibility, as you cannot get out even if it under-performs. ULIPs are not pure investment products for sure, but then why pay the price of mixing investment with insurance. While insurance should be for the long-term, investment doesn't necessarily have to be long-term.
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Please make me understand 'now it is expensive because of the opportunity costs and lacks in flexibility'. What oppurtunity costs & what flexibility —- ULIPS are more flexible than Traditional Plans or Mutual funds. One can switch units to more safer portfolios in the same ULIP plan without having to give switch charges (first few are free). Also there are so many features – SIP, ATP (Automatic Transfer from Debt to Equity – Twin advantage of SIP and some money always giving returns in Debt — Better than lumpsome investment or SIP alone). Lifecyle Portfolio , Trigger based portfolio, Dynamic P/E funds —- all these are according to some fundas , principles , logic — may or might not work in the long run … but some of these fundas are similar in logic to Quant MFs.
In reply to 'While insurance should be for the long-term, investment doesn't necessarily have to be long-term.' — Every person has different goals — some are short term and some are long terms. So whoever makes a plan, needs to plan for both with some investments planned for Long term. The problem does not lie with selecting a ULIP, the problem lies when a person selects ULIP for a short term goal (maybe some advisor has mis-informed him and sold him that product in that way), becuase ULIP can never be Short term products. When Insurance can never be short term, then how can a product which is a combination of Insurance and investment be short term.
I am not the person who advocates ULIP, but I feel ULIP fall in a grey area – mix of both White and Black.— its how well one is able to use the flexibilities in ULIP — it can end up giving good results. I feel that if your objective is Insurance — then the best and the most cost effective option is Term Insurance. If its Insurance plus Investment, with Insurance commanding more importance and for investment you want a safe & secure fixed growth – then Term insurance + PPF. If you are willing to take a bit more risk and ok with the equity component – then Term Insurance plus SIP in Equity Funds may work out the best option. With ULIPs – investment takes the center stage with varying amount of Insurance. But with the flexibility available – one can still make it a good investment. As I said at the very start that ULIP may be not a
great choice, but I do not completely agree with the reasons given here for not considering a ULIP becuase the comparison made is generic. Are you comparing it with Traditional Plans or Mutual Funds or Some combinations. The Points given are very vague in nature.
Thanks for your comments. I have not tried to compare ULIPs with any other investment product but I've tried to rate it on it's own merit here. Do you think, parting out more than 40% of one's own hard-earned money as charges is any incentive to investing in ULIPs? Please tell me with your own calculations as to how it "can still make…a good investment". That is, if you think my points are vague.
Firstly, thanks for replying back so soon. Secondly, I had to write so many comments separately — that was due to length constraints and not for any other reasons. Thirdly, I am sorry if you felt hurt by my choice of words ('vague'), I was maybe not getting the correct word while commenting, what I meant was that the article felt incomplete in its explaination. After you replied back to my comments – it feels the article more complete. Having said the above, let me give you further explaination / tips…. whenever you make any statement regarding one product is Expensive or one product is illiquid — then you have to do so in the light of other products or compare it to other products — to make the reasoning or statement more effective.
When you make a statement like 'With a plethora of charges as mentioned above, ULIPs are a very costly insurance product.' — then you are need to compare the expenses with Traditional Products… and if you consider ULIP as insurance+investment – then you need to compare it with MF+PPF , PPF or MF or any other — you cannot just say that its expensive without mentioning 'as compared to what'.
sorry that should be MF+Term Insu ; PPF + Term Ins
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