Ulips
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Most of you might have heard of ULIPs? Rather most of you might have heard your parents talking about an insurance cover? If your answer is yes, you are at the RIGHT place!
With 90% of t he insurance p olicies being sold as unit linked insurance policies, it beco mes even more im portan t to s tudy t hem.
What are Unit-Linke d In su ranc e Pl ans (U LI Ps) ? 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.
Risk s as so ci ate d wit h UL IP s ULIPS as the name suggests are directly linked with the investments made by the insured. Though he does not have a direct say in this but he does offer his choice in the form of investment. With stock markets soaring high a few months back, ULIPs were offering a good rate of return, but now with a sudden downfall of the stocks, ULIPs are bound to become negative investments. At present, a policy-holder cannot understand the growth of his investments vis-à-vis other funds in the market, since there is no benchmark to measure one fund against the other. Usually a policy-holder could ask his investment in a ULIP to be, for example, 55 per cent in equity and 45 per cent in debt. These components can be mixed according to his risk-taking ability. An investor, therefore, would have to look at quarterly statements, where the fund would be compared with benchmarks. However, this may not be a true representation of the NAV, as the ULIP could be a mix of debt, liquid and equity investments.
The reality is th at m ost of th e ULIPs ta ke more t han 5 years to brea k even. Policies whe re t he c osts are 65 per c ent and up wards h ave not even recovered th e prin cipal despite t he stronges t bul l mar ket w e have ever witnessed. Why do insurers p refer 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.
Whic h is be tte r, unit-link ed o r ‘wit h pro fits ’? The two strong arguments in favour of unit-linked plans are that — the investor knows exactly what is happening to his money and second, 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 installment. This eats into his savings, but ensures that the policy will continue to cover his life. UL IPs-investmen
t perspe ctive
In the short run, when market exuberance carries everyone on the money train, fund managers are its primary drivers
“Funds are invested in stoc ks wit h a long -ter m perspe ctive. Sin ce the investor decides h is risk appe tite in a p olicy, w e manage funds based on a conservative basis,” says Sashi Krishnan, chief investment officer of Bajaj Allianz Life in Pune. He says that a fund manager would invest in stocks that give a compounded growth rate of 20-25 per cent return over a period of 15-20 years.
ULI Ps ve rs us M utual Funds ( MF s) ULIP and MF may sound similar in structure, but there are various other things which separate these two investment tools. Below is a brief comparison of ULIP and MF specific to the Indian market. Primary Obje ctive MFs : Investments ULIPs: Protection + Investments Investmen t Duration MFs: Works out for Medium term, Long Term Investors. Risky for Short Term investors. ULIPs: Works out for Long Term Investors only. Flexibi lity MFs: Very flexible. Plenty of scope to rectify your investment mistakes if you made any wrong investment decisions. You can easily shuffle your portfolio in MFs. ULIPs: Flexibility is limited to moving across the different funds offered with your policy. Correcting mistakes can turn out to be expensive. Moving funds from one ULIP to another ULIP of a different fund house can be expensive. Liqui dity MFs: Very liquid. You can sell your MF units any time. Some MF's like those from Reliance have introduced redemptions at ATMs. ULIPs: Limited liquidity. Need to stay invested for the minimum number of years specified before you can redeem. Investmen t Obje ctive MFs: MF's can be used as your vehicle for investments to achieve different objectives. (Example: Buying a car three years from now. Down payment for a home five years from now. Children’s education 10 years from now. Children’s marriage 15 years from now. Retirement planning 25 years from now. Medical expenses after retirement 25 years from now) ULIPs: ULIPs can be used for achieving only long term objectives (Example: Children’s education, Children’s marriage, Retirement planning)
Tax Implications
MFs: All investments in MF's don't qualify for section 80C. ULIPs: Provide Tax Benefits under section 80C.
MFs: Tax liabilities when moving across from debt to equity funds. (Returns from debt MF's are taxed.) ULIPs: Very flexible in moving between equity and debt funds(not tax implications until maturity of the policy).
Strings At tac hed MFs: None so ever. At most you pay a small exit load if any. ULIPs: Some strings attached for your policy to be in effect. Minimum number of premiums needs to be paid. Minimum fund balance needs to be always maintained ADVA NTAGES UL IPS • Can easily rebalance your risk between equity and debt without any tax implications. • Best suited for medium risk taking individuals who wish to invest in equity and debt funds (at least 40% or higher exposure to debt). No additional tax burden for those investing mainly in debt unlike in MFs. ADVA NTAGE MFS • Better returns than ULIPs. • Lower charges than ULIPs. • Very flexible and enables you to switch your investments from non performing MF's to better performing MFs • Very Liquid can be redeemed at anytime. • Best suited for medium to high risk taking individuals who wish to invest a significant portion in equity funds (at least 65% exposure in equities). Suggested Readings: http://ulip.blogspot.com/ http://www.traderji.com/mutual-funds-discussion-forum/1350-unit-linked-insuranceplans-ulip.html http://in.rediff.com/getahead/2007/mar/23ulip.htm http://in.rediff.com/money/2004/mar/12perfin.htm
Business World 17th March 2008 (http://www.businessworld.in/content/view/3940/4047/1/0/)
With 90% of t he insurance p olicies being sold as unit linked insurance policies, it beco mes even more im portan t to s tudy t hem.
What are Unit-Linke d In su ranc e Pl ans (U LI Ps) ? 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.
Risk s as so ci ate d wit h UL IP s ULIPS as the name suggests are directly linked with the investments made by the insured. Though he does not have a direct say in this but he does offer his choice in the form of investment. With stock markets soaring high a few months back, ULIPs were offering a good rate of return, but now with a sudden downfall of the stocks, ULIPs are bound to become negative investments. At present, a policy-holder cannot understand the growth of his investments vis-à-vis other funds in the market, since there is no benchmark to measure one fund against the other. Usually a policy-holder could ask his investment in a ULIP to be, for example, 55 per cent in equity and 45 per cent in debt. These components can be mixed according to his risk-taking ability. An investor, therefore, would have to look at quarterly statements, where the fund would be compared with benchmarks. However, this may not be a true representation of the NAV, as the ULIP could be a mix of debt, liquid and equity investments.
The reality is th at m ost of th e ULIPs ta ke more t han 5 years to brea k even. Policies whe re t he c osts are 65 per c ent and up wards h ave not even recovered th e prin cipal despite t he stronges t bul l mar ket w e have ever witnessed. Why do insurers p refer 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.
Whic h is be tte r, unit-link ed o r ‘wit h pro fits ’? The two strong arguments in favour of unit-linked plans are that — the investor knows exactly what is happening to his money and second, 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 installment. This eats into his savings, but ensures that the policy will continue to cover his life. UL IPs-investmen
t perspe ctive
In the short run, when market exuberance carries everyone on the money train, fund managers are its primary drivers
“Funds are invested in stoc ks wit h a long -ter m perspe ctive. Sin ce the investor decides h is risk appe tite in a p olicy, w e manage funds based on a conservative basis,” says Sashi Krishnan, chief investment officer of Bajaj Allianz Life in Pune. He says that a fund manager would invest in stocks that give a compounded growth rate of 20-25 per cent return over a period of 15-20 years.
ULI Ps ve rs us M utual Funds ( MF s) ULIP and MF may sound similar in structure, but there are various other things which separate these two investment tools. Below is a brief comparison of ULIP and MF specific to the Indian market. Primary Obje ctive MFs : Investments ULIPs: Protection + Investments Investmen t Duration MFs: Works out for Medium term, Long Term Investors. Risky for Short Term investors. ULIPs: Works out for Long Term Investors only. Flexibi lity MFs: Very flexible. Plenty of scope to rectify your investment mistakes if you made any wrong investment decisions. You can easily shuffle your portfolio in MFs. ULIPs: Flexibility is limited to moving across the different funds offered with your policy. Correcting mistakes can turn out to be expensive. Moving funds from one ULIP to another ULIP of a different fund house can be expensive. Liqui dity MFs: Very liquid. You can sell your MF units any time. Some MF's like those from Reliance have introduced redemptions at ATMs. ULIPs: Limited liquidity. Need to stay invested for the minimum number of years specified before you can redeem. Investmen t Obje ctive MFs: MF's can be used as your vehicle for investments to achieve different objectives. (Example: Buying a car three years from now. Down payment for a home five years from now. Children’s education 10 years from now. Children’s marriage 15 years from now. Retirement planning 25 years from now. Medical expenses after retirement 25 years from now) ULIPs: ULIPs can be used for achieving only long term objectives (Example: Children’s education, Children’s marriage, Retirement planning)
Tax Implications
MFs: All investments in MF's don't qualify for section 80C. ULIPs: Provide Tax Benefits under section 80C.
MFs: Tax liabilities when moving across from debt to equity funds. (Returns from debt MF's are taxed.) ULIPs: Very flexible in moving between equity and debt funds(not tax implications until maturity of the policy).
Strings At tac hed MFs: None so ever. At most you pay a small exit load if any. ULIPs: Some strings attached for your policy to be in effect. Minimum number of premiums needs to be paid. Minimum fund balance needs to be always maintained ADVA NTAGES UL IPS • Can easily rebalance your risk between equity and debt without any tax implications. • Best suited for medium risk taking individuals who wish to invest in equity and debt funds (at least 40% or higher exposure to debt). No additional tax burden for those investing mainly in debt unlike in MFs. ADVA NTAGE MFS • Better returns than ULIPs. • Lower charges than ULIPs. • Very flexible and enables you to switch your investments from non performing MF's to better performing MFs • Very Liquid can be redeemed at anytime. • Best suited for medium to high risk taking individuals who wish to invest a significant portion in equity funds (at least 65% exposure in equities). Suggested Readings: http://ulip.blogspot.com/ http://www.traderji.com/mutual-funds-discussion-forum/1350-unit-linked-insuranceplans-ulip.html http://in.rediff.com/getahead/2007/mar/23ulip.htm http://in.rediff.com/money/2004/mar/12perfin.htm
Business World 17th March 2008 (http://www.businessworld.in/content/view/3940/4047/1/0/)
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