Since their introduction in the Indian market a few years back, unit-linked insurance policies (Ulips) have become a lot popular, but for all the wrong reasons. Here, I am not commenting on whether Ulips are good or bad as an insurance/investment product but trying to highlight the fact that among all the financial products Ulips are the most mis-sold (hawked as short term investment and tax saving product). Why? Because we are too pre-occupied either with earning more money or blowing away our hard earned money -- buying that newly introduced iPhone -- that there is hardly any time left for managing the money already earned (which is left at the mercy of the insurance agents or so called financial advisors).
In addition to rampant mis-selling, unit-linked plans are the most complex financial product. So let’s make an attempt to understand some of the unique but little known facts associated with them.
But, first the basics. Ulips are similar to traditional insurance products like money back and endowment policies because they also offer insurance-cum-investment but with one major difference. Ulips offer you market linked investing as opposed to assured returns offered by traditional policies. Put simply, in case of money back and endowment plans, investment risk lies with insurance company whereas in case of Ulips, insured have to bear the investment risk. There are lot many other aspects also (like transparency, liquidity, complexity and control) where Ulips differ from conventional insurance products. Besides, there are many hidden features which are unique to Ulips.
Here is a list of five such closely guarded secrets of ULIPs:
1. Minimum Premium
If you want to invest more than the minimum premium required for a particular sum assured, go for top-ups (additional investment over and above the regular premium) where the allocation charges are usually 1-2 per cent and thus work out to be cost-effective. Furthermore, unlike regular premium, there is no commitment on your part to pay it on regular basis.
So, what’s the way out? You should still go for the minimum premium only and if you would like to invest more, put up to 25% of your regular premium in Ulip as top-up and go for mutual funds for any amount over and above that.
Believe me, it can make a huge difference to your insurance costs and consequently to your returns and no insurance advisor is ever going to tell you about this well-kept secret because your loss is a direct gain to the agent and the insurance company.
2. Asset Reallocation Tool
ULIPs not only offer you to choose your equity exposure (from 0% to 100%) but through the option of fund switches also provide you the flexibility to shift between various fund options as per your convenience.
Thus, it is an ideal instrument to manage your asset allocation between debt and equity. Unlike mutual funds Ulips allow you to do asset reallocation at a click of button with no hassles, minimal/no cost and without any tax implications. Having selected an investment option, say 100% equity, you always have an option to shift to various other plans, say with 50% equity or 100% debt or any other combination.
In my opinion, this flexibility in altering the asset allocation is the best benefit ULIPs offer over mutual funds. Therefore, make the most of this tool but be wary of timing the markets.
3. Expense Ratio/IRR
The best way to compare ULIPs is to look at their expense ratio. It is arrived at by deducting IRR (also called net yield) from gross returns.
Gross Yield/Returns -------------10%
Less Actual returns / IRR ---------7%
Expense Ratio ---------------------3%
4. Type I vs Type II ULIPs
There are basically two types of ULIP plans. Type-I plans pays the higher of the sum assured and fund value to the nominees upon the death of life assured whereas in case of Type II plans both the sum assured and fund value are paid.
It is always preferable to opt for Type 2 policies which are more protection (the core aim of insurance) oriented -- although a bit expensive then Type-I policies due to high mortality charges -- because in case of Type-I policies risk exposure/sum at risk (sum assured minus fund value) keeps on decreasing in the later years as your fund value increases which amounts to having inadequate insurance coverage.
5. Termination/Surrender before 5 years
Like all insurance products, ULIP NAV are long term instruments and therefore it is better not to make an early exit.
As stated earlier, expense ratio is too high (in other words, IRR/net yield is too low) in the initial years. Furthermore, exit costs called surrender charges are applicable in case of early exits. Thus, you should let the ULIPs run their full term unless you are in financial crises.
Although most ULIPs allow full fund value if you surrender it any time after five or six years, it is better not to exit even after the 5 years and to let them run for at least 10 years because longer the policy runs, better the returns.
Furthermore, most ULIPs allow partial withdrawal any time after 3 to 5 years. But it is better not to opt for it unless you are hard pressed for funds.