The other side of ULIPs

Ever since the insurance Regulatory Authority of India (IRDA) banned a complex actuarial-funded product from insurance companies over two weeks ago, the spotlight is back on the tricky subject of ULIPs. They are the hot-selling products of insurance companies. Yet, there's a raging debate whether ULIPs are good for investors, and whether insurance agents are mis-selling them to net higher commissions. So, should you buy them or not? Here are a few key answers you must know about ULIPs.

What are ULIPs and what plans do they have?

ULIPs combine insurance and investing. A part of your investment goes towards insuring your life and the rest is invested on your behalf in different plans chosen by you according to your asset allocation. Your premium determines your life cover because there is no flexibility strictly speaking. Life cover is usually five or six times the premium paid up. These products typically come with a three-year lock-in. A typical ULIP plan will have the following components: insurance premium towards your life and investments in different asset classes. An 'aggressive' plan invests almost wholly in equities, a 'safe' plan invests in 70:30 equity and debt, and a 'balanced' plan invests 50:50. The buyer is allowed a limited number of switches between the plans.

What are the charges incurred in a ULIP?

In the first year, the overhead charges are around 25-30 per cent of the premium paid up in the first year. There is an entry load for the fund, typically around 5 per cent, and management fees or policy administration charges of around 1.5 per cent. Mortality charges, or insurance premiums, are deducted every year, which essentially covers your life. In case of any eventuality, your family gets the insurance amount.

In the first year, the agents get a higher commission paid through the overhead charges, which is the centre point of the debate. The next year, the overhead charges come down between 10 and 7.5 per cent, and from the fourth year onwards, it is 5 per cent. Fund management charges remain static.

What are the drawbacks of a ULIP?

As long as there are funds in your account to pay for the premium, your life is covered. If the unit value falls the next year to an extent they don't cover your insurance, you might be told to pay up the insurance premium, or your cover could lapse. Another thing, investments and insurance, they say, should be separated. They offer no guarantee unlike traditional plans which offer 6-10 per cent returns.

What agents don't tell you.

Many agents don't dwell on the various charges year on year. Clients are usually told that withdrawals are permitted from the third year onwards and the annual premiums will be taken care by the corpus in the fund. What they don't say is that if there are insufficient funds for payment towards mortality charges, the insurance cover lapses.

Look before you plunge

Don'ts

» Don't buy a ULIP because the agent is friendly and convincing-he may not be in this job tomorrow to be accountable to you later.
» Don't buy a ULIP purely for its 'aggressive' returns. Nobody can predict the market for the long term-bear spreads do happen in between.
» Don't buy a ULIP on the promise that you no longer have to pay your premiums after the third year and that you can withdraw funds anytime.
» Don't buy a policy without reading all the terms and conditions however tedious that may be. Also check out performance of funds for the past several years.

Dos

» Try to use the services of a certified planner; or better still talk to people in the know. Get quotations from various companies and zero in on the most efficient plan.
» All ULIPs are sold on the basis of returns. Make sure you understand the charges involved, and which fund is suited to your risk profile.
» Before you decide not to pay a premium or plan to withdraw funds-ensure that there is enough left to cover mortality charges and other administrative charges. The insurance cover may lapse without your knowing it.
» Your understanding is more important than the agent's target.

What are the regulations governing the expenses of a ULIP?

In a mutual fund, expenses are capped. But in a ULIP, insurers are given a greater leeway. In the event of the insured dying during the course of the plan, the sum insured or the funds left in the plan, whichever is higher, is given out to the surviving family. Very few give out both the sum insured and whatever is left in the fund, which would be more apt considering ULIPs deduct mortality charges anyway. A combination of a traditional pure life insurance or a term plan (without endowment benefits) and investment in mutual funds directly is a better option.

How many ULIPs are there in the market? Is there a true differentiation in products?

There are approximately 50 products in the market. Various products claim to be targeted for various requirements, but the variations are minor. There are only three types of life insurance-pure life or term plan without cash back, cash back at end of term, and regular payouts during various milestones. ULIPs combine the last two only. All ULIPs, whether they are children's plans or plans with bonuses, are essentially same, but with different payout structures. You can withdraw your money after the lock-in period, but by and large most ULIPs are front-ended products.

What should one do before buying a ULIP?

Don't get carried by NAVs which prevail for a few months-look at the track record of the fund for a few years. Don't assume that what is there in the NAV is what you will get-make provision for the charges. Don't buy any policy however persuasive the agent-without reading the fine print. If it is investment you are looking for, a systematic investment plan in an mf is more flexible and less expensive.