A spook in the guarantees

Unit linked insurance products (ULIPs) with a guarantee of premium are catching investors’ fancy. These ULIPs promise the safety of your capital, and some even promise an extra return over the long haul.

But dig deeper and it turns out there’s no real bonus. Many ULIPs charge you an additional administration and fund management fee than the plain vanilla variety. In some cases, the extra fees add up to a substantial amount.

Say no to guarantees Guaranteed plans have far higher costs than regular ULIPs, and do not work out to your advantage. If you allow your ULIPs to play out their term of 10 to 15 years, you will hardly face a loss of capital anyway. A regular ULIP can be monitored at intervals and you can switch between plans to optimise returns.

Consider this: an insurance company charges you administration fee of 3 per cent on sum assured of Rs 10,000 on a premium of Rs 2,000 per year. Over a 20-year period, the total charges work out to Rs 19,200. On your total investment of Rs 40,000, that’s close to 48 per cent. If the company gives you a 30 per cent addition on the capital investment, it’s merely returning your charges back.

On the other hand, the compounding effect also does not really work to your advantage. Say, insurance XYZ offers a 50 per cent addition for a 10-year premium paying term. Assume you pay a total premium of Rs 2 lakh, a 50 per cent bonus will take your final return to Rs 3 lakh. Over a 20-year term, that amounts to a CAGR of 2.6 per cent, which is lower than your 3.5 per cent bank fixed deposit.

What investors can do instead is to opt for a normal ULIP. A policy having close to zero or minimal overhead charges as a percentage of premium after five years is the best, but check how much of your premium is being invested in the initial years. In times of uncertainty, it’s best to use the switching facility to maximum effect and move to debt from equity.

—Nitya Varadarajan