Are ULIPs as good as advertised?
Life insurance is one of the most important steps to ensure your family’s financial security. But choosing the right plan can be overwhelming. Unfortunately due to conflicts of interest by most financial providers you do not always know everything you need to know about a product to make the right decision. ULIPs is one such product.
What are ULIPs?
Unit Linked Insurance Plans (ULIPs) in India are hybrid products combining investment and insurance. They invest your money in equity, debt, or both, offering market-linked returns along with life insurance coverage. Part of your premium funds the insurance; the rest is invested. ULIPs come with a minimum lock-in period of five years.
The drawbacks of ULIPs
Hidden Charges: ULIPs come with various fees like premium allocation charges, policy administration charges, fund management charges, mortality charges, and surrender charges. These fees can significantly reduce your actual returns.
Illusion of High Returns: ULIPs often advertise high returns without accounting for charges.
Insufficient Insurance Cover: The insurance component is often inadequate because a major portion of the premium goes towards investments. For instance, a ULIP might offer a ₹5 lakh cover, which is insufficient for most people.
Why are they popular?
Despite their drawbacks, ULIPs remain popular primarily because banks and insurance companies aggressively promote them. These institutions often push ULIPs to customers because of the high commissions earned from selling these products. The promise of potential high returns and tax benefits is heavily marketed, while the impact of fees and charges is downplayed. This aggressive selling strategy benefits the banks through substantial commissions but does not serve the best interests of the customers.
Taxation Changes
Previously, ULIP returns were tax-free under certain conditions. New regulations tax returns if annual premiums exceed ₹2.5 lakh, reducing their tax efficiency.
The Primary Purpose of Insurance
Excerpt from NISM: “The primary job of any insurance company is to provide risk coverage and not investment products. There are other entities that specialize in providing investment products. Ideally, risk coverage (insurance) products should be bought from insurance companies and investment products from entities that specialize in investment products.
Even if an insurance-cum-investment product is being considered, it can be evaluated as an insurance product that also has investment elements in it. The first thing is to decouple the insurance and investment elements of the instrument. Then the adequacy of the risk coverage needs to be examined. If the risk coverage is not adequate, then the instrument does not meet its primary goal and should be eliminated. Only after this primary requirement is met should the investment return be considered separately to see if it is suitable for the investor and meets her requirements and is also comparable with investment products with similar profile.”
Case Study
Imagine Atul, a 30-year-old professional, is evaluating two options to secure his family’s financial future: a Unit Linked Insurance Plan (ULIP) and Pure Term Insurance. Let’s break down how each option looks over a 20-year period.
Option 1: ULIP
Annual Premium for ULIP. ₹6,000
Sum Assured ₹1,00,000
Policy Term 20 years
Maturity Value ₹2,00,000
Option 2: Pure Term Insurance
Annual Premium for Term Insurance. ₹150
Sum Assured ₹1,00,000
Policy Term 20 years
Invest in Mutual Funds (Annually) ₹5,850
Here’s the impact:
In the ULIP, a part of the ₹6,000 premium goes toward investment, yielding a return of just 5.3%, while the rest funds the life insurance.
With the term plan, Atul secures pure life coverage for just ₹150 a year, freeing up ₹5,850 (₹6,000-150) for other investments with potentially higher returns.
After 20 years, Atul’s maturity value from the ULIP is projected at ₹2,00,000 if the returns meet expectations. The term insurance, while offering no maturity payout, provides flexibility; if he invested the ₹5,850 yearly in mutual funds with a 12% annual return, his investment could grow significantly to ₹4,21,506 yielding a higher return than the ULIP.
Why Term Insurance is better
Pure Protection: Term insurance provides pure life coverage without any investment component. This means you pay a premium solely for insurance protection, making it straightforward and uncomplicated.
Higher Coverage at Lower Cost: Term insurance policies offer substantial coverage amounts for significantly lower premiums compared to ULIPs or endowment plans. For example, for a cover of ₹1 crore, you might pay around ₹8,500 annually under a term plan, whereas a ULIP or endowment plan would require a much higher premium.
Maximising Investments: By opting for term insurance, you can invest the money you save on premiums into investment products that align with your financial goals and risk appetite, such as mutual funds, stocks, or fixed deposits..
Conclusion
While ULIPs may seem attractive, their hidden charges and fees often lead to lower actual returns. Banks and insurance companies promote them aggressively due to the high commissions they earn, but this may not align with your best financial interests. Separating your insurance and investment needs by opting for pure term insurance and investing in mutual funds or index funds can provide better financial outcomes and greater flexibility.