Insurance products have been typically used for indemnification which thereby meant that it was used for risk management. Since the money gets tied up for long, the prospect of using insurance for investments came into existence. To serve this purpose ULIPs were born.
ULIPs (Unit Linked insurance plans) are life insurance policies with the added feature of investments. They thus behave like Mutual funds, to some extent, and thus are also traded like mutual funds. Their value is represented in terms of NAV (net asset value). Since these units are tied to an underlying, their value depends on the value of the underlying at any point of time.
Just like in mutual fund, a pool of the funds collected through the premiums is created, the charges are reduced from it. The policy has the terms for the required returns and risks. The underlying is decided upon keeping this in mind. These funds are compared and traded in the capital markets. Thus, their performance is a function of the performance of the capital markets. Like in case of equity funds, an investor can diversify his portfolio by investing across a wide range of funds. The risk is, after all, borne by the investor.
ULIPs provide the investors the flexibility in choosing their investment style. They can pay a lump sum or making premium payments, be it annual, half yearly or quarterly. They can also the premium amounts during the tenure of the policy. This way, if during the tenure an investor has excess funds he can enhance the value of his investments, and on the flip side, a crunch situation allows him to invest lesser amount. He can also shift his funds across various plans like balanced funds, debt funds etc. the cost of doing so is nominal.
Expenses Charged in a ULIP
Premium Allocation Charge: A percentage of the payments made by the investor are appropriated towards the initial and renewal expenses. The balance is then transferred for the policy.
Mortality Charges: These are charges appropriated for the insurance cover. It depends on the factors like amount of coverage etc. basically the factors are identical to a normal insurance cover.
Fund Management Fees: Fees levied for management of the fund and is deducted before arriving at the NAV.
Administration Charges: This is the charge for administration of the plan and is levied by cancellation of units.
Surrender Charges:Deducted for premature partial or full encashment of units.
Fund Switching Charge:Usually a limited number of fund switches are allowed each year without charge, with subsequent switches, subject to a charge.
Service Tax Deductions:Service tax is deducted from the risk portion of the premium.
Types of ULIPS
ULIPS can be categorized on multiple parameters ranging from the risk of the underlying securities on which investment is made to the target profile of the ULIP product. We have done our analysis on a couple of these parameters which are most frequently used.
Based on Risk Profiles
ULIPS are often measured in terms of the risk associated with them. This categorization in turn depends on the profile of the underlying instruments that the ULIP plans intend to invest in. A subjective guideline could be as shown below:
General Description
Nature of Investments
Risk Category
Equity Funds
ULIPS invested in company stocks with the aim of capital appreciation
Medium to High
Income, Fixed Interest and Bond Funds
Corporate bonds, government securities and other fixed income instruments
Medium
Cash Funds
Also called Money Market Funds: Invested in cash, bank deposits and money market instruments
Low
Balanced Funds
A combination of both Equity and Fixed Interest Bonds
Medium
1
However, it is very rare to find ULIPS which follow a pure Equity or Fixed Income Bonds and most of the schemes going around in the market are a combination of both of the investment options available.
Based on Terms of Payment at Maturity/Death
Based on the amount reimbursed and the time of re-imbursement of the same, Unit Linked Insurance Plans can be divided into two distinct categories namely:
Type I ULIPS: These plans payback either the fund value as on date or the assured sum, whichever is higher, upon the death of the investor(policyholder) during the term for which insurance cover is sought
Type II ULIPS: These return both the sum assured and the fund value on the death of the policyholder. These are generally costlier than Type I ULIPS
In both scenarios the policyholder gets only the fund value on maturity i.e. if he survives the complete term of investment assurance. [2]
Based on the Target Customers (Demographic ULIPS)
All the major ULIP market players provide a host of these products tweaking them to make them attractive to a wide segment of the population Most of these are positioned to cater to differing financial requirements in a typical individual's life, hence we have customized ULIPS catering to Children's Education, Retirement, Health Expenses etc.
For eg: If we have analyze the ULIP products offered by ICICI Prudential in the market we get a view of the age wise demographic profiling done to appeal to all motives of investors as depicted in the illustration below:
3
The identification of the motives as shown above then leads to creation of products catering to these motives. In the case of ICICI Prudential the product portfolio provided is as follows:
Retirement
Retirement plans accumulate fixed savings over a period of time and guarantee a steady income post the retirement of the policy holder. These retirement plans usually have two phases:
Accumulation Phase: Pre-retirement phase in which the policy holder is required to invest a fixed amount regularly
Withdrawal Phase: Annuity benefits over the course of the policy holder's life span beyond his retirement.
The pension plan might allow lump sum payment or fixed yearly contributions. The amount collected is then invested in funds selected by the plan holder after reducing surcharges and payment towards insurance cover. This plan also allows tax-exempted withdrawal up to 33% of the fund at retirement. These plans are especially beneficial if investments begin at an early age as investments are compounded over time.
Wealth
These plans are targeted at young investors who have are looking for long-term financial requirements like purchasing houses. The added element of life cover serves to make these plans a wholesome financial investment option. [4] These can be further classified as
Single Premium/Regular Premium Plans: Plans with one time lump sum payment or regular installments
Guarantee plans - Non guarantee plans: Wealth creation ULIPs are generally non-guarantee plans which are exposed to market risks but lately a new category of high market return and low to negligible risk guarantee plans have been introduced. These are ideal for investors looking for high returns but averse to market risks. However, these are available only in the very long run investment horizon. The non-Guarantee plans, however, are more flexible and allow multiple options with varied levels of risk and return scenarios.
Life Stage based - Non life Stage based: Life Stage Based ULIP plans are customized to change the investment portfolios as well as the premium with varying stages of life. Initially the investment is higher in risky assets like equities whereas with age the portfolio is changed into a debt dominated instrument.
Children Education
These ULIPS are customized to pay returns at important junctures of a child's education, Also, the term insurance of the parent is inbuilt into this plan which ensures that the child receives timely payments for all educational requirements in case of the death of the parent.
These plans are often modified to add incentives like disability riders which take care of financial requirement in case of any such eventualities of the policyholder. [5]
Health
Health Care industry has seen booming business in the last decade or so and simultaneously the cost associated with health care has also spiraled. This has opened up demand for investment cum insurance funds which take care of these emergency cash flows.
Health ULIP has been the latest innovation to have emerged as a consequence of this demand from the health insurance industry. The health ULIP assigns a fixed proportion of the amount invested into savings that build a health fund that takes care of any future health related expenses whereas the rest of the amount is invested in other available investment options. The health fund is essentially a long term savings plan whereas the rest of the money is invested in equity/debt instruments to drive margins. A major benefit of using these health plans is that withdrawals at any stage for medical reasons are liable for tax benefits under the section 80 C. [6]
Despite the IRDA taking steps to educate consumers, there's a lack of knowledge about this product. An online survey on life insurance shows that over 50% of the respondents own a ULIP; most of them, however, had no clue about the amount of life cover they had.
The benefits of ULIPs can be presented as:
Long term investment plans
Insurance and investments combined together
With the cap on commission and pricing coming into picture, they become nearly as fair priced as MFs
Like warren Buffet said, it is good to start early. The ULIPs help you to start investing early on itself
Once you clearly understand the fine print of any ULIP policy, it becomes a useful product for long term investments.
The dividend payout tax sometimes discourages policies from paying out dividends. But this does not affect the returns for an investor because the retained amount gets reinvested and ultimately goes to the investor himself
The premium ULIP charges for providing insurance cover is considerably lower than what you would have to shell out for taking an independent policy with LIC. For instance, for a target amount of Rs 50,000 in a ten-year plan, assuming that you enter it at 26, ULIP deducts Rs 55 towards annual insurance premium. Whereas the annual premium for a similar fixed-term life cover from LIC would be in the range of Rs 1,000.
Drawbacks of ULIP
Liquidity: The ULIPs lead to a lack of liquidity since the funds once invested in the fund get locked in for a period of at least 5 years. Withdrawing before this means you would be foregoing the tax benefit attached to the schemes. Some claim that this lock in period is less than PFs, however it is also a much larger period than other schemes. Plus even beyond this, a penalty of 0.5% of the target amount is deducted for early withdrawal after 5 years. To improve this situation, a new policy to allow investors to withdraw after 7 years in a 10 year policy and after 10 years in a 15 year policy. They just need to maintain a minimum balance of rupees 5000.
Performance: ULIPs were offering a return of 13% under the previous method of administered pricing. But now with the switch to NAV based system, this becomes irrelevant since it has become a dunction of the unit's fund management skills and also the debt market conditions.
Size: The size of the funds (5000 crores in 2001) becomes a handicap for the fund managers as it impedes the maneuverability of the portfolio. It had invested 46% in equity which amounts to around 2200 crores. This made it the largest equity oriented fund in operation. This made it impossible to indulge in transactions without impacting the price of the stocks. Given the lack of depth in the debt market, the debt portfolio of Rs 2,679 crore, could prove to be even more of a white elephant. Moreover, as of December 2000, around 6 per cent of the NAV was set aside for non-performing assets.
Insurance cover: What's it worth?
Several tax saving plans are available in the market. Assuming that they are all at least as efficient as the ULIPs, the only differentiating factor remains is the insurance cover provided by the scheme. Out of the annual payments a small amount is deucted each year for the insurance premium and the remaining is invested into the fund.
Ulips are not easy to understand. Not many investors know about extrapolation of returns and can use spreadsheets to see how well their Ulips stack up. Besides, comparing Ulips is almost out of the question, no matter what the agent says. But investors don't seem particularly bothered about these negatives. The person who seeks advice, opinion and second opinion when he's buying a camera, blindly signs any form his agent hands out as long as he hears the magic words good returns .
Luckily, the industry and the regulator are concerned about this lack of knowledge, and they are doing what they can to improve investor education. Till a couple of years ago, Ulips were shrouded in mystery; nobody knew how the insurers charged for expenses, how the policies worked or what benefits were offered. Nobody seemed to want to know either. Investors were happy to believe the overzealous agents, who claimed the plans would give at least 30% returns. That led to rampant mis-selling, but investors remained blissfully ignorant.
To check mis-selling,
The regulator insisted on a 15-day free look period, allowing buyers to return policies that did not suit them. Today, several insurance companies offer this feature for a month.
Then IRDA also insisted on the agents providing the investors a policy illustration with a 6% and 10% return, standardising all charges across insurers, and a sales guideline that every agent had to follow. This is a first as no other financial product comes with an industry sales guideline.
Restrictive Terms.
One, it is restricted to the tenure of the plan.
Two, you will be eligible only to 50 per cent of the target amount, in the first six months of your entry into the plan.
Three, the insurance cover at any given time is equal to the difference between the target amount and the contribution paid. The contribution you paid will be received in the form of units to your credit, which you would be entitled to, in any case.
Four, women without an independent source of income are eligible only for a cover of Rs 40,000.
Comparison between balanced fund and ULIP
What is a balanced fund?
A balanced fund is a mutual fund that invests in equities as well as debt instruments. The purpose of the balanced funds is that it combines best of both worlds. It ensures a fixed and permanent flow of income through the debt investment side and benefits of capital appreciation through the equity investment side.
A balanced fund usually invests 40-60% funds in the equities and the remainder in the debt markets.
Comparison
The major benefit of a balanced fund over the ULIP is that it is low cost compared to the ULIP. It has a cap on its capital at 2.5%.
ULIP on the hand has a lot of charges accruable to it. The charges have been mentioned above. The utility of ULIPs is high only if u plan to remain invested for 8-10 years.
ULIPs have a short history and returns can vary hugely between one scheme and another. In the case of balanced funds, you can choose to take a shorter-term approach, without worrying about the impact of costs.
Most of the ULIPs are sold because of the three year lock in period. This facilitates continuation of life coverage till there is enough fund in your account to cover the mortality charges. Keep in mind that you may lose some or all of your money if you stop paying regular premium at least for ten years
Here is some data on how balanced funds and ULIPs have performed.
Balanced Fund
The HDFC Prudence Fund and HDFC Balanced Fund have provided robust returns of 16% over the past three years. The Canara Robeco Balance Fund, DSP BlackRock Balanced Fund and the Birla Sun Life 95 Fund have also yielded decent returns of 13% over the past three years. The average expense ratio of these funds is 2.5%.
ULIPs
HDFC Balanced Managed Investment-Life has yielded 11% returns over the past three years. ICICI Prudential Balancer II has yielded 11.75% over this period. Factoring the annual charges associated with these plans, the actual returns are much less. If you want life cover, you should, instead, opt for a pure term insurance policy. But if you are on the lookout for relatively safe and steady returns, you would be better off with a balanced fund rather than a ULIP
Comparison between mutual funds and ULIPs
Mutual Funds
Mutual funds are financial instruments wherein the funds are invested collectively and are managed professionally by fund houses. The investments are done in securities. These funds are purchased by investors so that their portfolios can be managed and monitored by the fund managers. The mutual funds invest funds in a collection of stocks which helps in diversifying the risk. Also, the presence of a collection of stocks helps in reducing the transaction costs.
Below diagram shows the basic working of MFs:
That generates
Which is invested in
Given back to
Pool their Money in
Basically the mutual funds can be categorised on the basis of the assets (Equity Stocks, Fixed-Income Funds and Money market funds). In case of equity funds which are the most popular type of mutual funds, the funds are further classified by the size of the companies and the investment style of the managers. The companies are categorized on the basis of their P/E and price to book value ratios. Other funds present are Global International Funds, Speciality funds and Index Funds
There are two kinds of costs attached with MFs. These are basically the ongoing fee and the transaction fee.
The mutual funds have a major advantage of being easily available and are thus easy to buy or sell. They can be easily bought from mutual funds companies or through third parties.
ULIPs VS Mutual Funds
ULIPs and Mutual Funds are two different financial instruments both serving separate functions. ULIPs act as both a market linked investment instrument and also as a life insurance instrument and are medium to long term in nature. Whereas, Mutual Funds are purely for investment and are short to medium term in nature. However they do have certain similarities as well. Both of these instruments are market linked for returns, and also they carry some market risk. Depending on the investor's selected stock performance, the returns will turn out to be similar. The major differences between the two instruments are:
Regulator:
Mutual Funds are regulated by SEBI, while, ULIPs are regulated by IRDA.
Entry Investment:
To enter into the MFs, a minimum investment amount is specified by the fund house. While, ULIP investment amounts are decided by the investor and can be varied. An investor having excess funds can increase the amount of premium he is investing. And an investor with a liquidity crunch has the option to reduce the amount of his premium.
Initial Expenses:
During the initial phase, ULIPs turn out to be an expensive proposition. This is because of an entry load which varies from 5-40% of the first year premium. Whereas, there is no such load on MFs. The expenses charged on MFs are usually management and administration fee and have an upper ceiling limit prescribed by SEBI. In case of ULIPs, there is no such ceiling by IRDA. The only restraint placed is on the fee charged towards the regulator. Due to these high expenses, lower amounts get invested and small corpus is accumulated.
e.g. Let the premium is Rs.10,000.
Let the Morality Charges deducted for insurance cover be Rs.1000.
The agent who sold the premium will get 25% of the first premium = Rs.2500
Hence, the premium cost left for investment will be Rs.6500
If (Net Asset Value) NAV of the fund rises, let say 30% in the first year, the portfolio worth will be Rs.8450, which is lesser than the premium.
In MF the total amount is invested.
Transaction fees are applicable Rs.30 or 1.5% of amount invested per transaction whichever is lower.
Transparency:
MFs have higher transparency as compared to ULIPs. They have to statutorily declare their portfolios on a quarterly basis and hence, investors get the opportunity to see where their monies are being invested and how they have been managed by studying the portfolio. On the other hand, ULIPs lack transparency.
Maturity:
ULIPs have a maturity period of around 5-20 years. They have a minimum lock in period of 3 years. Hence, ULIPs do not allow money to be withdrawn prematurely and levy a penalty on such withdrawals. MFs (except Equity Linked Saving Scheme, 3 years) do not have a lock-in period. They are more liquid. The open ended MFs, the liquidity is very easy.
Tax Benefits:
Irrespective of the plan chosen, ULIP investments help in attaining a tax benefit under section 80C of the Income Tax Act. Also, the maturity is tax free. The proceeds from ULIPs are tax-free under section 10(10d). While only the tax saving MFs such as ELSS attract such a tax benefit and the proceeds attract capital gains tax.
Flexibility in Asset Allocation:
ULIPs provide a greater flexibility in terms of altering the asset allocation. Insurance companies allow inventors to shift investments across various plans/asset classes either at a nominal or no cost. As a result, investors are given the option to invest across asset classes as per their convenience in a cost-effective manner. This is very useful for investors. For example, in a bull market when the ULIP investor's equity component has appreciated, he can book profits by simply transferring the requisite amount to a debt-oriented plan. In case of MFs, the flexibility is not there. In order to move from one type of investment to another, an entry and an exit fee is applicable which can make it quite expensive for the investors to move across portfolios.
The Conflict Between IRDA & SEBI
There are two major regulators involved in the regulation of the funds. SEBI & IRDA. Recently there was a major tussle between the two regulators about the authority over the regulation of these Funds.
SEBI
Securities and Exchange board of India was setup by Indian government in 1992 through SEBI Act as a regulator for securities market in India. Sebi takes care of interest of issuers of securities, the intermediaries and the investors.
SEBI is active in setting up regulations and pushing systematic reforms aggressively. It regulates all organizations involved in offering products based on investments in equity as well as debt market. It has introduced regulatory measures, norms, code of conduct and obligation to intermediaries like banks, brokers, portfolio managers, etc. It has structured the clearing houses of the stock exchanges. [7]
IRDA
The Insurance Regulatory and Development Authority (IRDA) was setup by the Indian government by IRDA Act 1999. The mission of this agency is "to protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto." [8] The agency regulates the companies offering insurance products and makes sure to protect the interest of policy holders.
The Conflict
SEBI regulates all stock market related activities. It manages mutual funds and other investment schemes that gain value by investing in the stock markets. ULIPs are a mix of investment and insurance. ULIPs are similar to mutual funds which invest in stock market with a part of insurance added.
When ULIPs were introduced they promised transparency, segregating and revealing the costs of insurance and investment components. But being a complex product it confused the policyholders by the structure of costs which is the part of the premium they paid. Different products defined various costs differently like "Premium Allocation Charges", "Premium Allocation Rate", "Policy Administration Charge", etc. All this along with mis-selling by the agents because of the high commission paid to them by the issuer companies caused the SEBI to take some action.
The ULIP are doing investments in the share market, hence, SEBI should have a control over these plans and should also have say in regulation of ULIPs.
SEBI's Actions
The market regulator issued a show cause to fourteen Insurance companies. It asked these companies why should not an action taken against them for selling investment based products without the permission of SEBI. As ULIPS are partially investment products, hence should also come under SEBI regulation as per the law.
Finally in April 2010, SEBI imposed a ban on issuing fresh Unit Linked Insurance Plans by these 14 insurance companies in India. The companies which received the order from SEBI include:
ICICI Prudential Life
Reliance Life Insurance
TATA AIG
HDFC Standard Life
Birla Sunlife
Max New York Life
SBI Life
Aegon Religare Life
Aviva Life
Bajaj Allianz
Bharti AXA
ING Vysya Life
Kotak Mahindra Old Mutual Life
Metlife India
The order didn't include state owned firm Life Insurance Cooperation (LIC). Also the order didn't include any change in existing product.
IRDA's response
After the ban the IRDA chairman J Hari Narayan assured the policy holders that the ULIPs are safe and secure. It asked the fourteen companies to ignore the ban and continue selling ULIP products. After few days SEBI modified its order and exempted all from the ban but made prior permission for new ULIPs mandatory. In the meanwhile the Finance ministry tried to settle the dispute and asked both to regulators to consult the court for clarification. SEBI asked the Supreme Court to hear to the petition. The apex later sent notices to all 14 companies and the center to transfer all cases to the Supreme Court. [9]
Resolution
The government finally ended the two-month long conflict between the two regulators by ruling that Unit-linked Insurance Products will be governed by the Insurance Regulatory and Development Authority. An amendment stating the above was signed by the President of India.
The ministry of Law stated that any unit-linked insurance policy and any such similar products are included in life insurance business and issued an ordinance to amend the RBI Act 1934, Insurance Act 1938, Sebi Act 1992 and Securities Contract Regulations Act 1956.
Present state of Laws and Regulation
The regulation of the financial industry in India is split among many organizations. This has resulted in many inefficiencies and tussle between these organizations like this one over ULIPs.
In the future, government needs to reorganize itself to fit the regulatory requirements of a sophisticated financial system, instead of trying to force financial firms to reorganize themselves to fit the almost accidental regulatory architecture that prevails in India today. [10] There is a need to have a combination of the Insurance Act, the IRDA Act, the SEBI Act and the SC(R) Act such that complex products like ULIPs which spans multiple domains can be regulated effectively.
Government Initiatives
Financial laws in India are in a bad shape and require a comprehensive rewrite. There has been 3 expert committee reports in the last three years -- the Percy Mistry report, the Raghuram Rajan report and the Jahangir Aziz report. In order to implement the plans for rewriting these laws, the budget speech by the Finance Minister announced the creation of the "Financial Sector Law Reforms Commission" (FSLRC) which should rewrite these laws into a small, modern, internal and a consistent set. [11]
Another need of the hour is the inter regulatory coordination so that issues like these can be handled and resolved internally. The budget announced setting up Financial Stability and Development Council (FSDC) which will try to foster better inter-regulatory coordination.
Recently two inter-regulatory matters have worked out comfortably:
Launch of exchange traded funds on gold
With cooperation of RBI, FMC and SEBI
Launch of currency futures
With cooperation between RBI and FMC
The FSDC should be put into place so as to play the important role in identifying and resolving these tussles and frictions that will increase as markets in India becomes more sophisticated and complex.
Analysis
Advantages
ULIPS have dual benefit of feeling of safety and they help investors remain invested.
They provide flexibility; investors can choose their term of insurance, the insurance cover they want, and pay premiums for a limited period if they wish to stop payments, or continue the payment.
They are transparent; investors know what amount they are paying for various benefits. The amount paid by investors is divided into three parts: the expenses, mortality premium and the investment amount. The expenses are those of the life insurance company and a major portion of that is the commission paid to the agent. Hence, in the initial years investors pay a huge amount. The mortality premium is the amount of money they will be paying for enjoying the life insurance cover. What remains is then invested. The investors can know the division of the amount among the given three categories.
Tax free returns; the returns from ULIPS is 100% tax free. Hence, it is a good tool to invest one's savings as against going for short term trading. The tax benefits are provided under section 80(C)
The investors can also switch between various options during the term of their contract, and can increase or decrease their cover amount or the amount they want to invest.
Disadvantages
ULIPS like several other investment products are subject to market risks. The money is invested in equities. Equity market is subject to fluctuations and thus the returns on this policy can't be assured. However it can be assumed that if a person stays invested for a long period of time in equity markets, the results will be positive.
Initial costs are very heavy. 15-20% is paid in the first year, while 5% is paid in the next two years.
ULIPS have a lock-in period. This is done in order to ensure that the costs don't weigh heavy on investors and the investment management becomes easy. However, this ties up an investor's capital, which creates problems in case investor requires money before lock-in period ends.
ULIPS are still at a nascent stage compared to other investment and life insurance options. People are not educated properly and the agents give a rosier picture in order to get clients for their commission. Many investors go for ULIPS since the agents tell them that they have the flexibility of not paying premium after three years. However, when premium is stopped after three years, most of the money is used for mortality premium and expenses. The amount actually invested is very less in this case. Hence, the returns are very low and often people don't understand the reasons behind this.
Although ULIPS provide for premature surrender, but there are high withdrawal charges which in effect reduce the returns an investor gets from the investments. Hence, this flexibility isn't advantageous in the real sense and is meant to be used by investors as last option for sourcing immediate need of funds.
In case the investor dies, ULIP gives the higher of value of investments and the insurance cover, not the both. So, in most cases, the investment is lost if the person actually dies and only the insurance cover is paid to the beneficiaries.
A Numerical Example
Let's take an example of someone (say Amit, 30 yrs old) who has Rs. 50,000 to spare. This will include investment amount plus premium for an insurance policy, sum assured of Rs. 250,000. Let's say Amit has no problem locking his money in for three years, but wants to exit after three years.
In a ULIP, Amit would pay (taking the Prudential ICICI Life Link 2 as an example):
- Entry load of 6% = Rs. 3,000
- Administration charges of Rs. 20 p.m. = Rs. 240 per year
- Mortality charges of Rs. 360 per year
- Fund management charges of 1.5% = Rs. 750.
This means the amount that is paid out as charges is: Rs. 4,350. Money actually invested using ULIP is Rs. 45,650/-
Now if Amit decided to use Equity linked saving scheme, ELSS for investment and a term plan for insurance.
Term plan cost (@Rs. 300 per lakh for 2.5 lakhs, the industry standard) = Rs. 750. Though some plans may have a minimum value more than this, but we can use it for illustration here.
Money left for investment = Rs. 49,250. If Amit puts this in an ELSS he gets charged:
- 3% entry load = Rs. 1,477.5.
- Fund management @1.25% = Rs. 615.6
So money invested using ELSS is Rs. 47,156.9/-
That means if Amit uses the ULIP route, around 2.5% LESS of his money is invested.
There's another disadvantage in case of type-I ULIPS, which has been considered in the above case. Let's say Amit dies in the third year - How much does his family get?
In ULIP case, the limit is the HIGHER of invested units or the sum assured, in this case: Rs. 2, 50,000.
In ELSS + Term Plan case, ELSS is recovered in full, around Rs. 50,000 (Assuming terribly low growth in three years of the invested amount) Term plan pays out full sum assured of Rs. 2,50,000. What this means is the family gets Rs. 3, 00,000.
In case of type-II ULIPS, the expenses are much higher than type-I ULIPS.
Conclusions and Recommendations
Investment in ULIPS requires patience. ULIPS are ideal for young people who can keep their money locked in for a longer period of time. It is an ideal product for children who may need a substantial amount of money for their education in the later part of their life.
ULIPS have high costs in early years. It is not a short term investment. It is also not meant for people with a short term goal. If an investor has a short term goal, he should prefer going for mutual funds or equity linked saving scheme along with a term insurance.
A substantial part of this is agent's commission. As fees and expenses are reduced in later years, the agents are not interested. In fact, most of the agents tell their clients that they don't "need" to deposit premium. Investors should guard themselves from such misconceptions as most of the premium paid later is invested into equities.
Investors should avoid all withdrawal options except in cases of serious cash flow constraints.
ULIPS is meant only for investors who have limited exposure to the world of investing, those passive investors who don't believe they can make the right decisions in choosing financial instruments. For financial-savvy investors, there are better options.
