Unit linked insurance policies (ULIPs) combine insurance and investment. They offer the perfect mix of higher returns, insurance, and tax benefits. ULIPs fulfil dreams. Customised retirement plans, pension plans, and children’s education plans – cater to every investor’s needs.
Yet, the reality is so different from the ULIP dream. The coronavirus induced market crash couldn’t have come at a worse time for ULIP investors. People chose ULIPs believing that they would create and protect wealth. Many policyholders whose ULIPs are maturing now are worried.
Unfortunately, mixing investments and insurance neither generates returns nor provides enough risk cover. Mis-selling is rampant. Agents market unsuitable products. Commissions and charges are against investor interest.
For instance, Tanisha was saving for her son’s education through fixed deposits. Her bank relationship manager suggested a ULIP specifically designed for higher education. Only when her son’s college education was imminent, did Tanisha realise that it was nowhere near enough. As she combed through the fine print, she noticed a large part of her investments were eaten away by charges. A back of the envelope calculation made her realize that Fixed Deposits might have worked out better!
Through this entire period, she didn’t have adequate life cover. If something had happened to her, her family would have suffered. Tanisha realised that investment decisions must be made on her risk appetite and investment horizons.
WHY ULIPS ARE NOT A GOOD CHOICE
Most ULIPs are purchased in the madness of March. The end of year deadline to save taxes pressurizes people to pick a product. However, tax benefits alone do not justify the pain ULIPs bring. High fees, volatility, and below-average returns are some pain points. The harsh truth is mixing investments and insurance in one product neither manages risk nor provides value for money.
ULIP VS TERM INSURANCE
Ashwin is a 30-year-old software engineer. He felt that a mix of ULIPs and term insurance worked better. The prospect of not earning any returns from term insurance was off-putting. So, he had a term policy and a ULIP of Rs. 25 Lakhs (each).
One day, Ashwin sat down to evaluate his choice. He knew that term insurance focused only on risk management. It was the smartest way to secure the future of his wife and children. Term insurance was very affordable. The glaring drawback was that he didn’t get any returns. So, he compared his unit-linked insurance policy with his term life insurance policy.
On the surface, it looked like Ashwin made a better deal with the ULIP. The death benefit is at least Rs. 25 Lakhs and if his fund performs well it could be a lot more. When he dug deeper, he noticed that he dedicated more of his cashflows towards ULIP premiums. What if he stuck only to term insurance and invested the difference in mutual funds? He could have Rs. 50 Lakhs of insurance and an additional Rs. 2.45 Lakhs to invest every year!
ULIP VS MUTUAL FUNDS
Most people choose ULIPs because of tax treatment. This is one of the features that make marketing ULIPs attractive. The merit of an investment decision doesn’t hinge on tax efficiency. ELSS returns are market-linked. Over a 3-5 year horizon, under normal circumstances, an investor can expect 9%-11% CAGR returns. On the contrary, ULIP returns vary significantly. This is because ULIPs invest across equity, debt, and hybrid funds.
ULIP VERSUS PPF
Ashwin also wondered how things would pan out if he chose a more conservative investment like PPF.
REASONS WHY YOU SHOULD NOT INVEST IN ULIPS
- Multiple charges: Premium Allocation Charge, Fund Management charge, Policy admin fees, Mortality charge, and Partial withdrawal charges apply to ULIPs. Whereas mutual funds have a single transparent expense ratio. When compared to the total charges for a ULIP, a mutual fund is far more investor-friendly.
- Lock-in period: Generally the lock-in period is 5 years. This means even if premium payments are stopped, the investor must wait for 5 years to access their money. Also, once the instalments are stopped, the funds are moved to a Discontinued Policy fund. During the period when funds lie in the fund, the insurer may apply a fund management charge which cannot exceed 0.5 per cent of the fund value. The returns from there on will be equal to the savings bank account (~ 3.0%). The Discontinued Policy fund will be paid out upon the completion of the lock-in period of five years.
- Does not fulfil needs: Inadequate risk cover and high premium to cover ratio when compared to Term insurance. Below average risk-adjusted returns when compared to other options like PPF or ELSS.
- Better alternatives: Term insurance plans also offer the same tax-saving benefit under 80 C that ULIPs have. Most savers are already covered by their EPF contributions. With term insurance, they have the flexibility to choose between PPF and ELSS as well.
Can we paint all ULIPs with the same brush? There are a few good products available online. They have lower commission margins compared to traditional ULIPs. However, the idea is to invest and be insured. Your life is worth a few Crores, not a few Lakhs. ULIPs will only be able to give you that kind of risk cover at a high cost. Therefore, saying no to ULIPs is in your best interests.