Almost everybody talks about investing in ULIPs, which are investment-cum-insurance plans killing two birds in one stone. It sounds good, but it isn’t!

“The Sensex is about to touch 28,000 points” said Mr Gupta, a life insurance advisor to Mr Kapoor his neighbour. “This is the right time to enter the market. Over the long term you’ll earn significant returns” assured Mr Gupta.

Mr Kapoor, age 30 year preferred the safety of fixed deposits and traditional insurance plans. He been had been privy to individuals who had lost everything in the stock market. He, like most Indians, feared erosion of capital and therefore abstained from investing in the stock markets.

But the pressure of keeping up with the Jones’ was getting to him. Every day at lunch, his colleagues boasted about “making a killing” in the stock markets through trading.

So, Mr Kapoor decided to invest a small portion of his salary in the stock markets. Trading in the stock market wasn’t his cup of tea. He was looking for a safe route to invest his money into equities and so decided to seek the help of Mr Gupta.

“What if I lose my money?” quizzed Mr Kapoor.

“Don’t worry; I have a perfect plan for you. It will give you the benefit of both the worlds—insurance and capital growth” promised Mr Gupta, who went on to recommend a Unit Linked Insurance Plan (ULIP). He quickly highlighted the benefits of investing in a ULIP:

 

• Regular / limited premium payment option—“You have the freedom to decide the premium payment term. You can pay a single premium or regular premiums”, highlighted Mr Gupta.

 

• Flexible fund options—they vary from pure equity to a mix of debt and equity, to pure debt. “You decide where you wish to invest. This would ensure you’re investing as per your risk profile. You may even switch from one option to other”, said Mr Gupta.

 

• Save Tax—“The plan offers tax benefits up to Rs 46,350 (approx.) under section 80C of the Income Tax Act, 1961. The redemption proceeds are tax-free too under section 10(10D) of the Income Tax Act” said Mr Gupta.

 

• Guaranteed death benefit—In case of demise of the life insured, the nominee would receive the higher of:
  • Sum Assured;
  • Fund Value;
  • 105% of the premium(s) paid

 

“This will ensure that your nominee would not loose on the fund value. Your nominee will always get the highest amount.” said Mr Gupta enthusiastically.

Mr Gupta then presented a sales benefit illustration to Mr Kapoor, depicting the future corpus value of his investments at an assumed rate of 4% p.a. and 8% p.a.

The picture seemed perfect. It was everything that Mr Kapoor was looking for. His fear of losing his hard earned money was pacified with Mr Gupta’s convincing arguments. Moreover, the tax planning season was round the corner and Mr Kapoor had not planned for his taxes. He found this to be a great opportunity to save on his taxes too. He decided to take the leap and signed on the dotted line.

This is usually how a conversation would end between a product distributor and an investor—with an investor trusting the agent and hoping to earn sizeable returns in the stock market.

But there is a catch…

A product distributor will share only limited information with his client. It induces him to blindly invest in a product without understanding the entire picture. Mr Gupta’s relationship with Mr Kapoor wasn’t different. He painted a picture and disclosed limited information which would excite Mr Kapoor to hand him the cheque.

So, before you fall prey to the sweet talk of your “well-meaning” product distributor and sign up for a ULIP scheme, be sure to check these 5 key factors:

 

• Charges: What you don’t know is that the insurance company allocates myriad charges to all ULIP schemes. These charges reduce the investible premiums thus lowering returns. Broadly, the list of charges and fees include:
  • Premium Allocation Charge: This charge normally includes initial and renewal expenses apart from commission expenses.
  • Mortality Charges: These are charges for providing you with a life cover. Mortality charges increases with age, amount of coverage needed, and poor state of health, etc.
  • Fund Management Fees: These are fees levied for management of the fund(s).
  • Policy/ Administration Charges: This could be fixed amount throughout the policy term or vary at a pre-determined rate.
  • Surrender Charges: If you stop paying your premiums for ULIP and surrender the policy to the insurance company to encash the accumulated fund value, before the completion of the policy tenure, a surrender charge will be levied.
  • Fund Switching Charge: Generally, in a ULIP there is a limited number of times you can switch from one type of fund to the other without a charge. With subsequent switches, you will be subject to a charge.
  • Service Tax Deductions: The applicable service tax is deducted from the risk portion which is the mortality charge of the premium.


• No guaranteed maturity value: The performance of a ULIP is market linked. So, there are no guaranteed proceeds at maturity. Although the insurance agent may highlight in his sales benefit illustration a return of 4% and 8% (as mandated by the insurance regulator), the returns may be in the red at maturity. Moreover, some of the charges (as mentioned above) are levied upfront thus reducing the investible premiums, which will go on to reduce the maturity proceeds.


• Premium vis-à-vis insurance cover: ULIPs offer a meagre insurance cover. Irrespective of what your insurance agent may say, the benefit on the demise of the life insured would be insufficient for your loved ones to meet life’s responsibilities.


• Track Records: ULIPs, unlike mutual funds, don’t disclose performance fact sheets. So, assessing how the ULIP is performing can be challenge, and a result timely portfolio action on your part may not be possible.


• Loans: Unlike traditional insurance plans, no policy loans are available for this product.

 

So, this brings us to the most important question—should you invest in ULIPs?

At the outset let us clarify that at PersonalFN, we believe your insurance and investment needs should be dealt with separately. Although ULIPs have become more cost efficient in the new form, their performance will always be tested against that of mutual funds.

You may decide to invest in a ULIP if you have already purchased an optimal term insurance cover (using the Human Life Value approach). But ensure that you proactively switch from equity oriented fund to a debt oriented fund as your age increases during the remaining policy term and as you move closer to the financial goals envisioned.  

In the interest of your long term financial wellbeing, engage in financial planning that can help you keep sync between investments with important financial goals in life

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