Unit-linked insurance: All charged up

February 22, 2005

ULIPs provide insurance cover with investment potential but they seem to charge more for bundling benefits.
What are ULIPs?

A unit linked insurance policy is one in which the customer is provided with a life insurance cover and the premium paid
is invested in either debt or equity products or a combination of the two.

In other words, it enables the buyer to secure some protection for his family in the event of his untimely death and at the
same time provides him an opportunity to earn a return on his premium paid.

In the event of the insured person's untimely death, his nominees would normally receive an amount that is the higher of
the sum assured (insurance cover) or the value of the units (investments).

However, there are some schemes in which the policyholder receives the sum assured plus the value of the
investments.

Every insurance company has four to five ULIPs with varying investment options, charges and conditions for
withdrawals and surrender. Moreover, schemes have been tailored to suit different customer profiles and, in that sense,
offer a great deal of choice.

The advantage of ULIP is that since the investments are made for long periods, the chances of earning a decent return
are high.

Just as in the case of mutual funds, buyers who are risk averse can buy into debt schemes while those who have an
appetite for risk can opt for balanced or equity schemes.

However, the charges paid in these schemes in terms of the entry load, administrative fees, underwriting fees, buying
and selling charges and asset management charges are fairly high and vary from insurer to insurer in the quantum as
also in the manner in which they are charged.

Tax benefits

The premiums paid for ULIPs are eligible for tax rebates under section 88 which allows a tax rebate of 20 per cent of
premiums paid for taxable income below Rs 150,000 and 15 per cent for income between Rs 150,000 and Rs 500,000.

Proceeds from ULIPs are tax-free under section 10(10D) unlike those from a mutual fund which attract capital gains tax.

Key features

Premiums paid can be single, regular or variable. The payment period too can be regular or variable. The risk cover
(insurance cover) can be increased or decreased.

As in all insurance policies, the risk charge (mortality rate) varies with age. However, for an individual the risk charge is
always based on the age of the policyholder in the year of commencement of the policy.

These charges are normally deducted on a monthly basis from the unit value. For instance, if there is an increase in the
value of units due to market conditions, the sum at risk (sum assured less the value of investments) reduces and so the
risk charges are lower.

The maturity benefit is not typically a fixed amount and the maturity period can be advanced (early withdrawal) or
extended.

Investments can be made in gilt funds (government securities), balanced funds (part debt, part equity), money-market
funds, growth funds (equities) or bonds (corporate bonds).
The policyholder can switch between schemes (for instance, balanced to debt or gilt to equity). The investment risk is
transferred to the policyholder.

The maturity benefit is the net asset value of the units. The value would be high or low depending on the market
conditions during the period of the policy and the performance of the fund manager.

Thus there is no capital protection on maturity unless the scheme specially provides for it. There could be policies that
allow the policyholder to remain invested beyond the maturity period in the event of the maturity value not being
satisfactory.

What you MUST ask your agent

First-year charges: Usually, a minimum of 15 per cent. However, high premiums attract lower charges and vice versa.
Charges can be as high as 50 per cent if the scheme affords a lot of flexibility.

Subsequent charges: Usually lower than first-year charges. However, some insurers charge higher fees in the initial
years and lower them significantly in the subsequent years.

Administration charges: This ranges between Rs 15 per month to Rs 60 per month and is levied by cancellation of
units.

Risk charges: The charges are broadly comparable across insurers.

Asset management fees: Fund management charges vary from 0.6 per cent to 0.75 per cent for a money market fund,
and around 1.5 per cent for an equity-oriented scheme. Fund management expenses and the brokerage are built into
the daily net asset value.

Switching charges: Some insurers allow four free switches in every year but link it to a minimum amount. Others allow
just one free switch in each year and charge Rs 100 for every subsequent switch. Some insurers don't charge anything.

Top-ups: Usually attracts 1 per cent of the top-up amount. Top-up normally goes directly into your investment account
(units) unless you specifically ask for an increase in the risk cover.

Surrender value of units: Insurers levy certain charges if the policy is surrendered prematurely. This levy varies
between insurers and could be around 75 per cent in the first year, 60 per cent in the second year, 40 per cent in the
third year and nil after the fourth year.

Fund performance: You could check out the performance of similar schemes (balanced with balanced; equity with
equity) across insurance companies.

Look at NAV performance over a period of at least two to three years. This can only give you some indication about the
credibility of the fund manager because past performance is no guarantee to future returns, especially in insurance
products where the emphasis is on long-term performance (10 years or more).

What happens if you miss a premium? Does the policy provide for a grace period or does the policy lapse? Under what
circumstances will the policy lapse? What are the exclusion clauses? Company policies on these points differ.

Here are some cardinal principles you need to follow when you buy insurance. Since an insurance agent is permitted to
sell only one insurance company's policies it is advisable to meet agents from different companies. That would help you
compare schemes across companies.

Since insurance is a product, which entails a long-term commitment on the part of the insurer, it is important not to go
only by the features or the cost advantages of schemes but by the parentage of the insurer as well.

Comparing schemes based on costs is a fairly complex exercise. As a rule, the higher the initial years' expenses the
longer it takes for the policy to outperform its peers with low initial years' costs and slightly higher subsequent year
expenses.

Retire unhurt

Pension plans are essentially tailored to meet old age financial requirements. But there are certain advantages in joining
a pension plan.
First of all, contribution to pension funds upto Rs 10,000 is eligible for tax deduction under section 80CCC. In other
words, your pension contribution will get deducted from your taxable income.

So if you are in the top tax bracket, liable to pay to a 30.6 per cent tax, then your tax savings will be that much.

All life insurance companies offer pension products - both conventional and unit-linked. In both cases you pay a certain
premium amount for a specified length of time.

Usually, the minimum entry age is 18 years and the maximum age is 60 years. You can choose to pay the premium for
five to 30 years. When the policy matures, you receive one-third of the value of the accumulated amount as a lump-sum
payment.

For the remaining, you can buy annuities either from the existing insurer or any other insurer.

While in a conventional scheme, your money is managed through the insurer's pooled investment account and you are
entitled to bonuses every year, in a ULIP you receive the value of the investment in your individual account.

In a ULIP you have the flexibility to choose between a conservative scheme or an aggressive scheme with high
allocation to equities. Pension policy impose huge penalties for early termination.

Most pension plans provides for four annuity options - (1) annuity for life, (2) annuity payable for a chosen term and for
life thereafter, (3) annuity for life with return of purchase price on death to the beneficiary and (4) annuity for life to you
and then to your spouse with return of purchase price to the beneficiary on death of last survivor - which can be
exercised at any time within six months of the vesting date or the date on which you are eligible for pension. Schemes
allow postponements of vesting age and also early retirement.

How does ULIP work?

Rahul is a thirty-year old who wants a product that will give him market-linked returns as well as a life cover. He wants
to invest Rs 50,000 a year for 10 years in an equity-based scheme. Based on this premium, the sum assured works out
to Rs 532,000, the exact amount of premium being Rs 50,032.

Based on the current NAV of the plan that Rahul chooses to invest in, he is allotted units in the scheme. Then, units
equivalent to the charges are deducted from his portfolio.

The charges in the first year include a 14 per cent sales charge, an administration charge (7 per cent for the first Rs
20,000 and 3 per cent for the remaining Rs 30,000) and underwriting charges, which are deducted monthly.

Besides, mortality charges or the charges for the life cover are also deducted. For the remaining nine years a 3.5 per
cent sales charge and an administrative charge of 4 per cent (for the first Rs 20,000 and 2 per cent for the remaining Rs
30,000) are levied in addition to mortality charges.

Fund management fee of 1.5 per cent (equity) and brokerage are also charged. This cost is built into the calculation of
net asset value.

On maturity - that is, after 10 years - Rahul would receive the sum assured of Rs 532,000 or the market value of the
units whichever is higher.

Assuming the growth rate in the market value of the units to be 6 per cent per annum Rahul would receive Rs 581,500;
assuming the growth rate in the market value of the units to be 10 per cent, Rahul would receive Rs 724,400.

In case of Rahul's untimely death at the end of the ninth year, his beneficiaries would receive the sum assured of Rs
532,000 or the market value of the units whichever is higher. Assuming the growth rate in the market value of units is 6
per cent per annum, the value of investment would be Rs 510,200.

However, his family will get Rs 532,000 as it is the sum assured.

Assuming a growth rate of 10 per cent per annum, the value of units at the end of the ninth year would be Rs 621,900.
Hence, the beneficiaries would get Rs 621,900.
Are unit-linked insurance plans good?
March 12, 2004 12:56 IST

Most insurers in the year 2004 have started offering at least a few unit-linked plans. Unit-linked life insurance products
are those where the benefits are expressed in terms of number of units and unit price. They can be viewed as a
combination of insurance and mutual funds.

The number of units that a customer would get would depend on the unit price when he pays his premium. The daily
unit price is based on the market value of the underlying assets (equities, bonds, government securities, et cetera) and
computed from the net asset value.

The advantage of unit-linked plans is that they are simple, clear, and easy to understand. Being transparent the
policyholder gets the entire upside on the performance of his fund. Besides all the advantages they offer to the
customers, unit-linked plans also lead to an efficient utilisation of capital.

Unit-linked products are exempted from tax and they provide life insurance. Investors welcome these products as they
provide capital appreciation even as the yields on government securities have fallen below 6 per cent, which has made
the insurers slash payouts.

According to the IRDA, a company offering unit-linked plans must give the investor an option to choose among debt,
balanced and equity funds. If you opt for a unit-linked endowment policy, you can choose to invest your premiums in
debt, balanced or equity plans.

If you choose a debt plan, the majority of your premiums will get invested in debt securities like gilts and bonds. If you
choose equity, then a major portion of your premiums will be invested in the equity market. The plan you choose would
depend on your risk profile and your investment need.

The ideal time to buy a unit-linked plan is when one can expect long-term growth ahead. This is especially so if one also
believes that current market values (stock valuations) are relatively low.

So if you are opting for a plan that invests primarily in equity, the buzzing market could lead to windfall returns.
However, should the buzz die down, investors could be left stung.

If one invests in a unit-linked pension plan early on, say when one is 25, one can afford to take the risk associated with
equities, at least in the plan's initial stages. However, as one approaches retirement the quantum of returns should be
subordinated to capital preservation. At this stage, investing in a plan that has an equity tilt may not be a good idea.

Considering that unit-linked plans are relatively new launches, their short history does not permit an assessment of how
they will perform in different phases of the stock market. Even if one views insurance as a long-term commitment,
investments based on performance over such a short time span may not be appropriate.

Unit-Linked Insurance Plans (ULIP)

Unit-linked insurance plans, ULIPs, are distinct from the more familiar ‘with profits’ policies sold for decades
by the Life Insurance Corporation.

‘With profits’ policies are called so because investment gains (profits) are distributed to policyholders in the
form of a bonus announced every year.

ULIPs also serve the same function of providing insurance protection against death and provision of long-
term savings, but they are structured differently.
In ‘with profits’ policies, the insurance company credits the premium to a common pool called the ‘life fund,’
after setting aside funds for the risk premium on life insurance and management expenses.

Every year, the insurer calculates how much has to be paid to settle death and maturity claims. The surplus in
the life fund left after meeting these liabilities is credited to policyholders’ accounts in the form of a bonus.

In a ULIP too, the insurer deducts charges towards life insurance (mortality charges), administration charges
and fund management charges.

The rest of the premium is used to invest in a fund that invests money in stocks or bonds.

The policyholder’s share in the fund is represented by the number of units.

The value of the unit is determined by the total value of all the investments made by the fund divided by the
number of units.

If the insurance company offers a range of funds, the insured can direct the company to invest in the fund of
his choice. Insurers usually offer three choices — an equity (growth) fund, balanced fund and a fund which
invests in bonds.

In both ‘with profits’ policies as well as unit-linked policies, a large part of the first year premium goes
towards paying the agents’ commissions.

Which is better, unit-linked or ‘with profits’?

The two strong arguments in favour of unit-linked plans are that — the investor knows exactly what is
happening to his money and two, it allows the investor to choose the assets into which he wants his funds
invested.

A traditional ‘with profits,’ on the other hand, is a black box and a policyholder has little knowledge of what
is happening. An investor in a ULIP knows how much he is paying towards mortality, management and
administration charges.

He also knows where the insurance company has invested the money. The investor gets exactly the same
returns that the fund earns, but he also bears the investment risk.

The transparency makes the product more competitive. So if you are willing to bear the investment risks in
order to generate a higher return on your retirement funds, ULIPs are for you.

Traditional ‘with profits’ policies too invest in the market and generate the same returns prevailing in the
market. But here the insurance company evens out returns to ensure that policyholders do not lose money in a
bad year. In that sense they are safer.

ULIPs also offer flexibility. For instance, a policyholder can ask the insurance company to liquidate units in
his account to meet the mortality charges if he is unable to pay any premium instalment.

This eats into his savings, but ensures that the policy will continue to cover his life.

Are ULIPs similar to mutual funds?

In structure, yes; in objective, no. Because of the high first-year charges, mutual funds are a better option if
you have a five-year horizon.

But if you have a horizon of 10 years or more, then ULIPs have an edge. To explain this further a ULIP has
high first-year charges towards acquisition (including agents’ commissions).
As a result, they find it difficult to outperform mutual funds in the first five years. But in the long-term, ULIP
managers have several advantages over mutual fund managers.

Since policyholder premiums come at regular intervals, investments can be planned out more evenly.

Mutual fund managers cannot take a similar long-term view because they have bulk investors who can move
money in and out of schemes at short notice.

Why do insurers prefer ULIPs?

Insurers love ULIPs for several reasons. Most important of all, insurers can sell these policies with less capital
of their own than what would be required if they sold traditional policies.

In traditional ‘with profits’ policies, the insurance company bears the investment risk to the extent of the
assured amount. In ULIPs, the policyholder bears most of the investment risk.

Since ULIPs are devised to mobilise savings, they give insurance companies an opportunity to get a large
chunk of the asset management business, which has been traditionally dominated by mutual funds.

You can try Bajaj Allianz Child gain policy. This policy is conventional, you have to pay primium on
yearly/half yearly basis till the child is 18 years. I would suggest that you invest the money on your child's
name in some of the new unit linked policy, you have to pay the primium for min 3 years, you may withdraw
the entire amount when your child become major. The growth is excellent.

Instead of going for a child policy do consider having

a. Term Policy ( on parents name) - nominee child represented by guardian
b. Investing in an equity diversified mutual fund(s) in SIP

Pl refer www.valueresearchonline.com for MF's - Do not forget to consider expense ration while shortlisting
MF's..
I am doing a Govt Job earning 13000/- per month and I have taken a 5lacs LIC moneyback policy for 20 yrs
in 2003 with a monthly premium Rs2185/-. Can any body tell me how much amt I get after every 5 yrs and
at 20th year. Finally Is it a good policy or not ? Is there is any good method for Tax saving and Insurance
coverage better than LIC moneyback policy?

This is my first post at Traderji.. and i describe myself as a novice who is still learning..well the post have
been quite informative on ULIP... I recently had invested in bajaj Allianz ULIP...and frankly speaking i m
regretting doin so...

well the reason primarily is...

1) its a complete hotch potch of insurance and investment...
2) My 15K investment is actually 11K .. rest all the money eaten up as insurance charges..
3) i cannot track down the performance of ULIP like the way i do it with MF...
4) NAV's are difficult to find out and payment modes are quite complex...
5) I m tied down paying 15K for next 3 yrs.. no other go..

Right now i do not hv enuf time to elaborate .. but for young investors like me... i can only advise... do not
opt ULIP as tax saving instrument... insurance+investment funda is a toral non sense...

opt individually for insurance (term insurance) and keep investment avenues seperate...

the same thing was advised by my financial consultant also .. but i did'nt listened to him... and now i m stuck
with this....
Hi,
I am investing 2000/- PM in MetSmartPlus ULIP of MetLife.I dont know the performance of the Metlife in
the past.Can any one suggest me is it ok to invest on....
And also i want to invest in SIP MFs around 2000/- which SIP is good to go for..i am expecting returns in an
1 or 2 years period..

Thanks for suggesting.

Thanks
Ram