ULIPs came into bad light in the 2000s as newly launched insurers capitalized on the madness in equities and the aggression of sales channels to create products which were inherently not in the interests of the clients. High commissions to distributors prompted sellers to push the products to policyholders who often did not have the ability to take on market risks or stay invested for the long-term. A major turning point came with the Insurance Regulatory Authority of India (Irdai) regulations of 2010 , then from 2015 onwards, with caps on expenses, and the 2018 bonanza which introduced LTCG on Mutual Funds- ULIPs are now now back in fashion as they now make eminent sense for investors looking to park their wealth for the long term.
WHAT ARE ULIPs
A Unit Linked Insurance Plan is essentially a mix of insurance and investments. When you invest in a ULIP (Unit Linked Insurance Plan), the insurance company invests a part of the premium in shares/bonds, as per the plan chosen, and the insurer utilises the balance amount in providing an insurance cover. Ulips are meant to provide wealth creation opportunities or meeting retirement planning needs.
ULIPs were first introduced by UTI in 1971 as an effective financial tool with guaranteed additional cover. However, due to high charges, lack of transparency and commissions to distributors and agents, its acceptance got hollow with time. Then private insurers started off with their own versions – and continued to become blockbusters into the late 2000s.
Then came the private sector’s tryst with IRDA – the Insurance Regulatory Authority of India (Irdai) regulations of 2010 brought to its knees the industry by removing a lot of areas that were leading to lack of transparency or sheer investor rip-offs!
The 3G Ulips entered the scene in 2015 with an online-only model and zero premium allocation charges and so on but couldn’t really do much as the perception of ULIPs was completely shattered.
What we are now seeing are the fourth generation ULIPs where charges are capped on overall basis – and in fact are lower than what mutual funds are allowed to charge! (In Annualised ULIP charges are capped at 2.25% for first 10 years. It is similar to expense ratio of Mutual fund investment capped at 2.5%.).
Not only charges but new guidelines such as increasing disclosures, minimum lock-in period increased to 5 years and commissions capped, the new age ULIPs have become a much better financial product for investors.
The 4G Plans!
Earlier, ULIPs had almost 5 layers of costs apart from high surrender charges – Premium Allocation charges , Fund Management Charges, Policy Admin Charges, Mortality Charges, Switching Charges and so on.
Current regulations ensure that you don’t have to worry too much about the costs in unit-linked insurance plans (Ulips). Why? Because regulations now define the maximum an insurer can charge you. In mutual funds, you know this cap as expense ratio, which simply means the maximum that a company can charge you in percentage terms.
In the current available plans from the likes of ICICI Prudential, HDFC Life and Bajaj Allianz, quite a few insurers have removed premium allocation charges, are refunding mortality charges, charging mutual fund comparable fund management charges, reduced switching charges to nil and reduced premium allocation charges to minimal possible.
Also, as per regulations, charges should be levied in a manner that the reduction in yield (RIY)—the difference between gross yield and net yield—is not more than 2.25% on maturity for a policy with a duration of more than 10 years. If the duration is 10 years or less, then the difference between the total return and post-cost return can’t be more than 3% on maturity. This has led to a situation where you can rest assured that the returns on an 8% (illustration) policy would be closer to 6% -6.4% post charges.
However, this excludes mortality charges- which range from 0.2% to 0.6% typically on premium for providing the insurance cover.
The other major boost to ULIPs has come from the introduction of LTCG on equities which ensures that over longer horizons, tax savings on ULIPs can more than make up for the deficiencies which may exist in ULIPs.
In essence, unlike earlier, when most advisors were preferring a combination of mutual fund investments plus term cover over a ULIP – this is no longer s straightforward decision and one has to carefully study ULIPs before choosing to ignore them.
- Like mutual funds, and on a monthly basis, insurance companies publish their factsheet which discloses their entire portfolio where all expenses are clearly stated upfront.
- Investors can choose to get the mortality charge back once the plan matures
- Fund Management charges are capped at 1.35% per annum which are comparable to mutual funds
- ULIPs also provide customers with the flexibility to choose their asset allocation between equity and debt, depending on their risk appetite. In fact, the customer has the option to choose their investment in 100 % equity or debt. Further, many insurance companies do not even levy charges for switching between the funds any number of times during the year – unlike a mutual fund where charges and taxes would both apply.
- After 5 years the policyholder can choose to withdraw their investments partially or fully.
- In the case of ULIPs, there is tax deduction available under section 80C of the income tax act. So for ULIPs purchased after April 1, 2012 and where the annual premium is less than 10 per cent of the sum assured, the entire premium amount can be claimed for deduction. Also, at the time of maturity, subject to the same condition mentioned above, the proceeds are tax free under section 10(10D).
- By not allowing exits prior to 5 years, ULIPs also inculcate a regular habit of saving and investing, which is important for building wealth over the long term and keeping your loved ones financially safe and covered at all times!
- Features like return of mortality charges, additional allocations by the company and loyalty additions by some insurers sweeten the deal further. This is in sharp contrast to the earlier era, when some plans charged up to 100% of the first year’s premium as premium allocation charges.
- Unlike SIPs in ELSS, Ulip investors can redeem the entire amount at the end of five years even if the premium has been paid in instalments. In ELSS, only units that have completed the three-year lock-in can be redeemed.
AND THE DISADVANTAGES
- Mutual funds score over ULIPs in the flexibility they offer. You can redeem investments in an under-performing fund and switch to a better performing scheme. ULIPs do not allow such mobility and you have to of course switch between schemes of the same insurer as exits are very very expensive.
- Also, you can stop SIPs in case of a financial crunch or if you are dissatisfied with your choice of fund and exit with minimal hassles. However, not servicing your Ulip premiums could result in your policy lapsing.
- Non-equity funds are eligible for indexation benefit after three years. If the returns are below inflation levels, you can claim a loss and adjust against other taxable gains, or carry forward the loss for up to eight years. This is not possible with ULIPs.
ULIPs- FOR WHOM
Over the long term, ULIPs are more efficient with the 4G Plans as costs other than mortality and Fund management virtually don’t exist.
If a customer has an investment horizon of over 10 years, ULIPs will offer a better IRR especially due to the Tax-free status which will appeal to HNIs as well as those who are already invested into taxable instruments.
However, over shorter terms, ULIPs become unattractive due to the charges, low probability of exits etc.
In terms of fund management, ULIPs have shown their ability to match most mutual funds so the returns aspect, especially with a larger brand, may not be a reason to choose one over the other.
ULIPs are however not suitable for those who are not confident of recurring income over five to seven years or are likely to need their money in the interim. Those in their 60s are also better off staying away from ULIPs unless buying into a longer term plan.
One can have ULIPs to create a tax-free pool with which to fund liquidity, contingency, goals in the future, five years after purchasing the ULIPs. Looked at it this way, it can be a useful part of the client’s portfolio.
Our counselors across the country can help you choose the best of plans from some of the largest insurers in the country so please do remain in touch with us at firstname.lastname@example.org .