Jul 22, 2009

ULIPs: Top 10 FAQs

Photo by Oberazzi

While making decisions about money matters, it is always better to be informed instead of relying on hearsay and rumours or making wild guesses.

Unit-linked Insurance Plans (Ulips) which combine the features of mutual funds with life insurance are considered as the most complex financial products available in the market. This post makes an attempt to demystify various features of Ulips. Here’s a list of top ten FAQs about Ulips:


ULIP FAQs:

FAQ-1: What are ULIPS?
Unit-linked insurance plans, popularly known as Ulips are life insurance policies which offer a mix of investment and insurance similar to traditional life insurance policies such as endowment, money-back and whole-life, but with one major difference. Unlike traditional policies, in Ulips investment risk lies with the insured (i.e., policy holder) and not with the insurance company. Put another way, in case of adverse market conditions, you can even lose your capital invested.


FAQ- 2: What are the other differences between Ulips and traditional insurance plans such as endowment and whole life? Which is better between the two?
In addition to the risk factor, comparison can be made between the Ulips and traditional Insurance Plans based on various parameters such as returns, transparency, flexibility and liquidity.
Read more.


FAQ-3: What are the different types of Ulips?
Broadly, there are two kinds of Ulips - Life insurance Ulips & Pension Ulips. Here we are discussing only life insurance Ulips.

Further life insurance Ulips can be categorized into two types: Type 1 & Type II Ulips. Type II Ulips which offers both the sum assured and fund value in case of death are certainly better than Type I Ulips.
Read more.

Besides, there’s another way to classify Ulips: Guranteed Ulips and normal / Plain-Vanilla Ulips. To know more about guaranteed Ulips, see the
review of SBI Life - SMART ULIP.


FAQ-4: What are the various fund options available in Ulips?
The biggest misconception about Ulips is that they are entirely linked to equity markets. The fact is that, within an Ulip policy various fund options exist with varying exposure to equity and debt such as 100% equity fund, 100% debt fund, and balanced fund. Most ULIPs available in the market usually offer you a choice of 5 to 7 funds.

You’ve to choose the most suitable fund option according to your needs and risk profile. Thus, if you’re risk averse investor, option to invest your entire premium (net of charges) in a debt fund is also there.


FAQ-5: What is a fund switching facility in Ulips? How many fund switches are allowed in a year?
Ulips certainly score over mutual funds when it comes to fund switching.

After initially choosing a fund or funds at the time of buying a ULIP, you’re further allowed to switch / shift between different fund options any number of times you wish. However, there is a cap on the maximum numbers of fund switches allowed during a year free of cost. Beyond that, the policy holder has to pay a flat charge per switch.

This is one of the closely guarded secrets of Ulips and is to be used over and over again. However, remember that it can also backfire if you are not careful because frequent switching amounts to timing the markets.


FAQ-6: What are various costs of Ulips?
In Ulips expenses do matter and can make a big difference in the IRR of the policy.

Here’s a list of various charges:

1. Allocation charges: Also called premium allocation charge (PAC), it is deducted from the premiums paid to cover the marketing and distribution costs (including agents commission) of ULIPs. Usually in the initial 2-3 years, allocation charges are on the higher side (called front-loading) of charges. From 3rd or 4th year onwards, premium allocation is reduced to 2% - 5% in most of the Ulips.

2. Administration charges: These charges are deducted monthly on flat basis to meet the general administration and management costs of ULIPs. However, Some Ulips charge policy administration charge as a percentage of the annual premium amount (e.g. 2% of the annual premium) but adjust it from the fund value each month.

3. Mortality charges: This is the cost of life insurance cover provided to the insured. Mortality charge is a variable charge levied on monthly basis and depends on mortality rate (which depends on your age, gender and health) and sum at risk (SAR = Sum assured minus fund value in case of type I Ulips). For Type I Ulips, as the fund value keeps on increasing, ‘sum at risk’ decreases and consequently mortality charges also decreases.

4. Fund Management charges: This is a fee charged (as a percentage of funds under management) for managing your investments. It usually ranges from 0.5% to 2% depending on the insurer and the type of fund and is deducted before arriving at the NAV. In other words, NAV figures published by insurers are after deducting the fund management charges from the gross returns earned by the fund. In a sense, it is an invisible cost and you won’t even feel it. Besides, it’s impact also increases with the rise in the fund value as it is levied on percentage basis on the fund value. However, FMC charges are usually lower in Ulips as compared to mutual funds.

Allocation charges are fixed, front-ended and deducted from the premium and net premium is invested. Mortality charges are variable in nature and are usually deducted on monthly basis by cancellation of the units. Similarly, administration charges which may be levied either on flat or variable basis are deducted on monthly basis by cancellation of the Units. Finally, FMC charges, as already mentioned, are also variable and automatically adjusted /deducted from the NAV.

Besides, there are certain other miscellaneous charges such as surrender charges (levied in case of premature exit), fund switching charges (in case of number of switches exceeds the free switches allowed in a year) and top up charges.


FAQ-7: What are Top-ups? Whether top-ups are also eligible for section 80C tax benefit?
The additional investments––over and above the regular premium––you’re allowed to make in Ulips are called top-ups.

Yes, of course, for the purpose of tax deduction under section 80C of the Income Tax Act, there’s no difference between regular premium and a Top-up premium.

In fact, Top-Ups are another hidden secret about Ulips.
Read more.


FAQ-8: How to compare / evaluate various Ulips?
Comparison between various Ulips can be made based on two broad parameters. First is cost or internal rate of return (IRR) and second criteria is the fund performance as depicted by actual gross returns (growth in NAV over a period of time) being generated by various funds of Ulips. Finally, the best ULIP is one with the lowest cost structure and highest relative returns.

However, while making comparison we’ve to ensure apple-to- apple comparison. Put simply, Type I Ulips have to be compared with other Type-I Ulips only and not Type II Ulips. Furthermore, while comparing two Ulips, fund options also need to be similar. An equity fund option of, say, Type II Ulip can’t be compared with debt fund option of another Type ULIP II ULIP.

To know the ranking of Ulips based on IRR, go to
Best Ulips based on IRR.


FAQ-9: Are Ulips better than Term Plans?
No, absolutely not! Term insurance plans are better than Ulips. If you truly understand the meaning of life insurance, then there’s nothing compared to term plans.

Though it may seem counterintuitive, in my view, term plans should be the only product sold by Life Insurance Industry. However, in reality, term plans are least sold life insurance policies in India.

Just imagine a car showroom selling you every kind of vehicle other than the car (such as SUVs, Trucks and Tractors) and only after your repeated requests and pleading the salesman reluctantly agrees to show you the car.


FAQ-10: Can Ulips be surrendered and what are the implications?
Yes, it is very much possible to make a premature exit from Ulips. However, there are certain tax and cost considerations to be kept in mind before moving out. For more details, check out:
How to Surrender or Get rid of Life Insurance Policy.


Do you've any other question or opinion regarding ULIPs? Feel free to leave it in the comment box.


Also see:

1. 5 Top Misconceptions about Life Insurance

2.
Understanding Life Insurance – Ask Yourself a Few Questions

3.
Most Amazing Fact about Life Insurance

4.
Is it Complexity or Confusopoly?

5. Capping of ULIP Charges by IRDA - A Review

4 comments:

  1. sir,
    very true.once the innocent policy holders came to know about policy ALLOCATION charges, some pvt. life insurance companies innovated policy admnistration charges(upto 40% of annual premiums).only GOD knows how they convinced or manipulated irda!
    a mere 2.25% commision in mutualfunds is denied and 40% pluus with huge incentives in life insu**

    rance!
    thanks
    what a pity

    ReplyDelete
  2. Katya MehraApril 10, 2010

    Hi Fisher,
    Came across this article on valueresearchonline.com. i am sure you've read it. What is your view on this? How will it impact all existing ULIP holders? I am one such unfortunate ULIP holder.....
    SEBI Begins ULIP Crackdown; Blocks all activity on existing products
    http://new.valueresearchonline.com/story/h2_storyview.asp?str=101346Pls let me know your valuable views. Thanks
    Katya

    ReplyDelete
  3. Katya,

    See the latest post "Sebi bans sale of Ulips"

    ReplyDelete
  4. So should one ever go in for a ULIP ? I know you said, the financially unsavvy should, but should't anyone else ever buy ULIPs ?

    What about the taxation benefit at maturity ?
    ULIP are tax-free while MutualFunds are taxed ?

    There is a cap to how much one can put into PPF. If I buy a term-plan insurance, and want to invest regularly for the next 15 years and build a tax free corpus, what should I invest in ?

    ReplyDelete

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