UNIT-linked insurance plans (ULIPs) are the flavour of the season. Launched a couple of years ago, these plans have contributed over 50 per cent of the new business of insurance companies such as ICICI Prudential and Birla Sun Life.
Encouraged by the response, other players, too, are launching variants of savings and endowment plans in the unit-linked format. A recent addition to the range of insurance products,
ULIPs claim to give an investor the best of both worlds — high returns and risk cover. But look deeper, and you find shortcomings. So do consider the following points before going in for a ULIP.
1. It is prudent to make equity-oriented investments based on an established track record of at least three years over different market cycles. ULIPs do not fulfil this criterion now.
2. Insurance and savings are two different goals and it is better to address them separately rather than bundle them into a single product. A combination of a term plan and a mutual fund could give better results over the long term.
3. If investment returns are your priority, you should compare alternative investment products before locking in your money.
4. Tax advantages do work in favour of ULIPs for debt-oriented funds. For equity-oriented funds, equity-linked savings products, which enjoy tax advantages and provide market-linked returns, are comparable.
5. The expense structure of insurance products does significantly dent returns.
Returns not sustainable...
The core selling point for unit-linked plans are the high returns generated over the past couple of years.
The growth options have recorded annualised returns of over 20 per cent — a distant dream for an insurance product in an era of non-guaranteed returns. Most non-linked savings plans declare annual bonuses (investment returns) in the 4-5 per cent range.
As insurance companies have the discretion to decide on their investment portfolios, ULIPs can even have a 100 per cent equity component. But non-linked plans do have an IRDA-stipulated cap on investment in various asset classes. A minimum of 50 per cent has to be invested in State and Central Government securities and only 35 per cent can put into corporate debt or equity.
In the long run (say, a 20-year term), the average return from a non-linked plan might work out to 5-6 per cent. In comparison, a linked plan appears far more attractive, at least on the face of it.
... but one has to remember that
These high returns (above 20 per cent) are definitely not sustainable over a long term, as they have been generated during the biggest bull run in recent stock market history.
The free hand given to ULIPs might prove risky if the timing of exit happens to coincide with a bearish market phase, because of the inherently high equity component of these schemes.
While a debt-oriented ULIP scheme might be superior to a debt option in a conventional mutual fund due to tax concessions that insurance companies enjoy, such tax incentives may not last.
Look beyond NAVs
The appreciation in the net asset value (NAV) of ULIPs barely indicate the actual returns earned on your investment. The various charges on your policy are deducted either directly from premiums before investing in units or collected on a monthly basis by knocking off units.
Either way, the charges do not affect the NAV; but the number of units in your account suffers. You might have access to daily NAVs but your real returns may be substantially lower.
A rough calculation shows that if your investments earn a 12 per cent annualised return over a 20-year period in a growth fund, when measured by the change in NAV, the real pre- tax returns might be only 9 per cent. The shorter the term, the lower the real returns.
How charges dent returns
An initial allocation charge is deducted from your premiums for selling, marketing and broker commissions. These charges could be as high as 65 per cent of the first year premiums. Premium allocation charges are usually very high (5-65 per cent) in the first couple of years, but taper off later. The high initial charges mainly go towards funding agent commissions, which could be as high as 40 per cent of the initial premium as per IRDA (Insurance Regulatory and Development Authority) regulations.
The charges are higher for a linked plan than a non-linked plan, as the former require lot more servicing than the latter, such as regular disclosure of investments, switches, re-direction of premiums, withdrawals, and so on. Insurance companies have the discretion to structure their expenses structure whereas a mutual fund does not have that luxury. The expense ratios in their case cannot exceed 2.5 per cent for an equity plan and 2.25 per cent for a debt plan respectively. The lack of regulation on the expense front works to the detriment of investors in ULIPs.
The front-loading of charges does have an impact on overall returns as you lose out on the compounding benefit. Insurance companies explain that charges get evened out over a long term. Thus you are forced to stay with the plan for a longer tenure to even out the effect of initial charges as the shorter the tenure, the lower your real returns.
If you want to withdraw from the plan, you lose out, as you will have to pay withdrawal charges up to a certain number of years.
In effect, when you lock in your money in a ULIP, despite the promise of flexibility and liquidity, you are stuck with one fund management style. This is all the more reason to look for an established track record before committing your hard-earned money.
Evaluate alternative options
As an investor you have to evaluate alternative options that give superior returns before considering ULIPs.
Insurance companies argue that comparing ULIPs with mutual funds is like comparing oranges with apples, as the objectives are different for both the products.
Most ULIPs give you the choice of a minimum investment cover so that you can direct maximum premiums towards investments.
Thus, both ULIPs and mutual funds target the same customers. If risk cover is your primary objective, pure insurance plans are less expensive.
When you choose a mutual fund, you look for an established track record of three to five years of consistent returns across various market cycles to judge a fund's performance.
It is early days for insurance companies on this score; investing substantially in linked plans might not be advisable at this juncture.
Moreover, with the market at a high, if you get your timing wrong, your long-term returns could be compromised. Linked plans should have minimum allocation in your portfolio of investments at present. One may consider linked plans favourably about three years from now, when one can assess their record.
If you already have a ULIP, these tips can help you lower your costs and increase returns.
Try top-ups
Insurance companies allow you to make lump-sum investments in excess of the regular premiums. These top-ups are charged at a much lower rate — usually one to two per cent. The expenses incurred on a top-up including agent commissions are much lower than regular premiums.
Some, like Aviva, also give a credit on top-ups. For instance, if you pay in Rs 100 as a top up, the actual allocation to units will be Rs 101. If you keep the regular premiums to the minimum and increase your top ups, you can save up on charges, enhancing returns in the long run.
Reduce life cover
The price of the life cover attached to a ULIP is higher than a normal term plan. Risk charges are charged on a daily or monthly basis depending on the daily amount at risk. Rates are not locked and are charged on a one-year renewal basis.
Your life cover charges would depend on the accumulation in your investment account. As accumulation increases, the amount at risk for the insurance company decreases. However, with increasing age, the cost per Rs 1,000 sum assured increases, effectively increasing your overall insurance costs. A lower life cover could yield better returns.
Stay away from riders
Any riders, such as accident rider or critical illness rider, are also charged on a one-year renewal basis. Opting for these riders with a plain insurance cover could provide better value for money.
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