What are ULIPs - Unit Linked Insurance Plans?

It is safe to say that Indians clearly understand the scarcity of financial resources and thrive to save a massive chunk of their earnings. They are always in a constant hunt for the best investment product. A few decades ago, the banks were the most trusted option for many. But later on, various financial and non-financial institutions evolved and constructed various avenues that potential investors could choose among.

As the competition rose, innumerable instruments with varying features took birth. There is an alternative for every individual who’s looking to park his funds and earn returns, irrespective of his age, financial goals, income-generating capacity, or any other factor.

One such option is Unit Linked Insurance Plan. If you are looking for an insurance policy but also want to park some of the funds in the financial market without hassle, this article would surely interest you. 

Continue reading to understand the intricacies of ULIP.  

What is a ULIP?

Unit Linked Insurance Plan (ULIP) is an investment instrument offered by insurance companies. It is a unique avenue that is a combination of both insurance and investment. The first ULIP was launched in the year 1971 by Unit Trust Of India (UTI). Gradually when the Indian economy opened up to welcome foreign investors in the insurance sector in 2001, India witnessed many players enter the market to offer ULIP. The Second ULIP came from LIC Mutual Fund in 1989.

This is an improvised version of what we all know as an endowment policy. The latter has a few drawbacks which were overcome by the former. For example, there is no clear distinction between the proportion of premium allocated to insurance and the investment that the investor is informed about in the endowment policy. ULIP provides this transparency.

Let’s now dive deep into the topic and understand more about this investment product. 

How do ULIPs work?

As already mentioned, ULIPs are a combination of insurance and an investment plan. Any investor who chooses to invest in ULIP pays an amount periodically, known as premium. A proportion of this premium is utilized to provide insurance coverage, and the rest is parked for investment purposes. The funds apportioned towards investment are put into various debt and equity securities based on the investor’s risk appetite. 

The investment mechanism is quite similar to that of a mutual fund. The insurance company pools up the money received from all its policyholders, and invests it. Fund managers manage these funds, and investors are assured that their funds are handled in the best possible way.

The investors are also given an option to switch their funds between debt and equity as per their preference. 

Is there a lock-in period?

Before 2010, the lock-in period for ULIP was three years. In 2010, India’s Insurance Regulatory and Development Authority (IRDAI) increased this limit from 3 years to 5 years. It must be considered that if a ULIP is surrendered in the first three years, the insurance cover will cease immediately. However, the surrender value can be paid only after three years.

Types of ULIP funds

There are various types of ULIP funds an investor can choose to invest in. a couple of them are listed below.

• Equity funds

These funds imply the amount in the equity shares of one more company in the financial market. Though equity is a highly risky investment option, the growth prospects and returns are also very high.

• Debt funds

ULIPs also can invest the entire quantum of funds in the various debt instruments available in the market like debentures, bonds, government securities. This option is usually chosen by a risk-averse investor who wouldn’t mind earning lower returns.  

• Liquid funds

Here, the fund managers park an investor’s funds in money market instruments. These instruments include treasury bills, call money, and certificates of deposit (CD), and other short-term instruments. This is a good option for short-term investment goals.

• Cash funds

For investors looking to invest in instruments bearing the lowest risk, investing in cash fund instruments such as term deposits, cash deposits, and market funds is ideal. 

• Balanced ULIPs

This type of ULIP involves investing in a combination of both equity and debt instruments. This helps exploit the advantages of both these options while significantly reducing the risk.

• Life-staged ULIPs

This is similar to the balanced ULIP. The premium received is invested in both equity and debt. Life staged  ULIPs function with an assumption that as an investor ages, his risk appetite falls. So, initially, the proportion of funds invested is high in equity, and this proportion gradually reduces as the investor grows older.

• Single premium and regular premium ULIPs

As the name suggests, a policyholder based on his financial soundness can either pay the premium amount during purchase or period payments. These periodic payments could be monthly, quarterly, semi-annual, or annual.

Tax benefits

Before an investor puts his money into an instrument, he considers the tax benefit one major factor. So does ULIP offer any tax benefit? Yes, it does. The principal amount invested in ULIP is exempt under Section 80C of the Income Tax Act, 1961 up to an upper limit of Rs.1.5 lakhs. The returns from the policy also do not attract any tax liability.  

Fees and Charges

Now that we’ve understood the various types available and the tax benefits one can reap from ULIPs let’s look at some of the fees and charges associated with the same.

• Premium allocation charges

To cover the initial expenses of an insurance company like agent’s commission, medical expenses, cost of underwriting, etc., a percentage of the first-year premium is charged. The balance amount is invested in the chosen fund.

• Administration charges

A periodic fee, usually monthly, is charged by the insurance company to cover its administrative expenses.

• Fund management charges

This is a fee charged for managing the funds. The fund manager efficiently regulates the funds to ensure maximum returns to the policyholders. For this, a fee as a percentage of the fund’s value is charged. The IRDAI regulates the maximum limit of the percentage that can be charged.

• Switching charges

ULIP offers investors to switch their funds from one instrument to another. When the number of switches crosses a fixed limit, switching charges apply.

• Mortality charges

The insurance company also charges a fee for providing insurance to the policyholder. This fee is based on the insured’s age, health condition, amount, and duration of the life insurance policy.

• Surrender charges

When the policyholder surrenders the policy before it matures, surrender charges are levied. This depends on whether the policy was surrendered pre or post the lock-in period. As per the IRDAI regulations, only the acquisition cost incurred shall be recovered.

Should you opt for ULIP?

In addition to the tax benefits, lock-in period, and the switching facility, there are few things one should consider before investing in ULIPs.

• Financial objectives

ULIPs are one of the best alternatives available for someone looking for long-term savings and wealth creation.

• Risk appetite  

This is another essential factor to be considered before investing in ULIPs. Though ULIPs have a varied spectrum of options, it is not as diversified as other alternatives available, like the ELSS scheme.

• Charges levied

It is crucial to analyze the various insurance companies offering ULIPs and their charges. This is important to ensure that the returns earned are not set off with the charges levied.

• Benefits of standalone plans

Most financial advisors are of the opinion that if one invests in mutual funds and insurance independently, the returns earned would be much higher than that earned in ULIP.

Conclusion

Before 2010, ULIP was considered a scam due to a few private insurance companies’ misdeeds. Later on, the IRDAI did step in to amend regulations related to ULIP. ULIP is a good investment alternative for potential investors looking for a one-stop destination.

However, the single-most yet biggest problem in ULIP is that they aren’t exactly a sweet spot between equity and insurance. You don’t get more than decent returns. Neither you get appropriate insurance coverage. Hence, you might be better off investing in shares and insurance separately as well.

So, what do you think? Would you invest in ULIP?