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.
Source: http://blogs.rediff.com/bestulipinsurancepolicy/2016/06/20/ritikashah11998-32/
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