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.