Unit linked insurance plan (ULIP) is life insurance products that provides for the benefits of protection and flexibility in investment.
UlIPs have always been controversial products that the insurance companies sell aggressively and were first launched in 2001. They are generally promoted as “short-term plans” by the agents. ULIPs in actuality are not short-term plans but have a span of 10-15 years and can be surrendered after 3 years.
ULIPs have a front loaded fee structure. In most of the ULIPs, only 30-45% of the first year premium is deducted as charges and the rest invested in the fund of choice, so for the fund to achieve break-even stage, it will generally take more than 3 years. Subsequently, the charges come down and a higher portion of the premium is allocated to the fund of choice.
ULIPs have a slew of charges in them and some of them are:
PREMIUM ALLOCATION CHARGE: A percentage of the premium is appropriated towards charges, initial and renewal expenses apart from commission expenses before allocating the units under the policy.
MORTALITY CHARGES: These are charges for the cost of insurance coverage and depend on number of factors such as age, amount of coverage, state of health etc.
FUND MANAGEMENT FEES: Fees charged for management of the fund and is deducted before arriving at the NAV.
ADMINISTRATION CHARGES: This is the charge for administration of the plan and is levied by cancellation of units.
SURRENDER CHARGES: Deducted for premature partial or full encashment of units. Surrender is not allowed for the first 3 years.
FUND SWITCHING CHARGE: Usually a limited number of fund switches are allowed each year without charge, with subsequent switches, subject to a charge.
SERVICE TAX DEDUCTIONS: Service tax is deducted from the risk portion of the premium.
The important thing to note about ULIPs is that the overall charge structure for the plan comes down substantially over a long term. However it may be noted that insurers have the right to revise fees and charges over a period of time.
Many investors, mostly retail, believe insurance to be a part of investment portfolio and the insurance companies capitalize on this false conception and sell ULIPs over traditional insurance products.
Insurance is primarily a product for protection, whereas mutual funds are products for investments. ULIPs provide very low cover as the cover is generally 5-7% of the premium. For a similar premium, the traditional policies would have a much higher life cover.
Insurance thus should be used to protect and mutual funds should be used to create wealth over the long term. Mixing the two benefits more to the insurance companies than to the insured (investor).
For any investment, one should look for transparency and liquidity, unfortunately ULIPs have neither and mutual funds on the other hand are both transparent and liquid. UlIPs are not transparent as the charges are ad hoc and hidden. UlIPs cannot be encashed before 3 years and thus do not have liquidity whereas mutual funds can be encashed at any given time. Mutual funds do not have any entry or exit load after the new regulations have kicked in whereas the ULIPs still have mind boggling charges.
The pitch that your friendly banker (bancassurance) or your agent may build in favor of ULIPs:
Tax efficiency: ULIPs are often pitched as tax-efficient because the investment is eligible for exemption under Section 80C of the Income Tax Act (subject to a limit of Rs 1 lakh) but investments in ELSS schemes of mutual funds and 5 years bank fixed deposits, PPF, NPS are also eligible for exemption under the same section. Besides the premium, the maturity amount in ULIPs is also tax-free, irrespective of whether the investment was in a balanced or debt plan. Here, the debt fund option of ULIPs have an edge on debt mutual funds, as debt funds are taxed at 10% without indexation and 20% with indexation. The point to note, however, is that with the high charges of ULIPs despite its tax-efficiency the post-tax returns will be negative to low because of high front-end costs (in all probability debt fund of ULIPs will give a negative return even after 6 years). Debt mutual funds do not have such charges.
Banks (bancassurance) and insurance agents get high commissions for ULIPs, and they get them in the initial years, not staggered over the term like in traditional policies. So the insurer recovers most of the charges in the initial years. Insurers charges heavy marketing and distribution charges (read commission to agents), averaging more than 30% of the first year’s premium, and dropping down in subsequent years. The older products (2004-2005) had even higher charges. Compare this with mutual funds’ fees of 0% on entry, 0% on exit uniformly for all schemes.
As an illustration an agent (bank or otherwise) who sells you a ULIP may get 30% of your first year’s premium. If your annual premium is Rs 100,000 and the agent’s commission in the first year is 30%, it means only Rs 70000 of your money is invested in the first year effectively meaning a 30% return will make you gain break even status.
On the other hand, if you invest Rs 100,000 in an equity scheme with a 0% entry load, Rs 100,000 gets invested and if the market gives a 30% return your investment is worth Rs 130,000. This shows how ULIPs work out expensive for investors.
So what is the best way to mix the insurance and investment? Undoubtedly, a mixture of term insurance (very low cost and high cover) and mix of equity and debt mutual funds.
From the above illustration (assuming market grows by 30%) and one deducts the cost of a term policy from the mutual fund returns, one can still make a good return as compared to breaking even in case of an ULIP.
The insurance companies have now come up with a novel “Highest NAV Guaranteed” schemes in the market. These products too are nothing but making a fool of the gullible investors. Before buying these products keep these two points in mind:
1. Let us assume the premium paid is 100,000 and one is paying the premium for 3 years (these products have only 3 premium paying years unlike traditional ULIPs which are 10-15 years policies and one cat stop paying after 3 years). So the total premium paid is 300,000. Now assuming the insurance company charges a total of 40% as various charges over the 3 years, meaning only 180,000 gets invested and 120,000 is deducted as charges. So even with the “Highest NAV” the investor is unlikely to make much profits, in this illustration 40% growth of NAV is required only to break even.
2. The “Highest NAV Guarantee” is only valid if you survive the insurance policy period, if you do not, the nominee gets the basic cover which from the second year is generally 1.25-2 times the premium.
ULIPs thus are products which are in Unlimited Income Products for the insurance companies, banks (bancassurance) and agents.
UlIPs have always been controversial products that the insurance companies sell aggressively and were first launched in 2001. They are generally promoted as “short-term plans” by the agents. ULIPs in actuality are not short-term plans but have a span of 10-15 years and can be surrendered after 3 years.
ULIPs have a front loaded fee structure. In most of the ULIPs, only 30-45% of the first year premium is deducted as charges and the rest invested in the fund of choice, so for the fund to achieve break-even stage, it will generally take more than 3 years. Subsequently, the charges come down and a higher portion of the premium is allocated to the fund of choice.
ULIPs have a slew of charges in them and some of them are:
PREMIUM ALLOCATION CHARGE: A percentage of the premium is appropriated towards charges, initial and renewal expenses apart from commission expenses before allocating the units under the policy.
MORTALITY CHARGES: These are charges for the cost of insurance coverage and depend on number of factors such as age, amount of coverage, state of health etc.
FUND MANAGEMENT FEES: Fees charged for management of the fund and is deducted before arriving at the NAV.
ADMINISTRATION CHARGES: This is the charge for administration of the plan and is levied by cancellation of units.
SURRENDER CHARGES: Deducted for premature partial or full encashment of units. Surrender is not allowed for the first 3 years.
FUND SWITCHING CHARGE: Usually a limited number of fund switches are allowed each year without charge, with subsequent switches, subject to a charge.
SERVICE TAX DEDUCTIONS: Service tax is deducted from the risk portion of the premium.
The important thing to note about ULIPs is that the overall charge structure for the plan comes down substantially over a long term. However it may be noted that insurers have the right to revise fees and charges over a period of time.
Many investors, mostly retail, believe insurance to be a part of investment portfolio and the insurance companies capitalize on this false conception and sell ULIPs over traditional insurance products.
Insurance is primarily a product for protection, whereas mutual funds are products for investments. ULIPs provide very low cover as the cover is generally 5-7% of the premium. For a similar premium, the traditional policies would have a much higher life cover.
Insurance thus should be used to protect and mutual funds should be used to create wealth over the long term. Mixing the two benefits more to the insurance companies than to the insured (investor).
For any investment, one should look for transparency and liquidity, unfortunately ULIPs have neither and mutual funds on the other hand are both transparent and liquid. UlIPs are not transparent as the charges are ad hoc and hidden. UlIPs cannot be encashed before 3 years and thus do not have liquidity whereas mutual funds can be encashed at any given time. Mutual funds do not have any entry or exit load after the new regulations have kicked in whereas the ULIPs still have mind boggling charges.
The pitch that your friendly banker (bancassurance) or your agent may build in favor of ULIPs:
Tax efficiency: ULIPs are often pitched as tax-efficient because the investment is eligible for exemption under Section 80C of the Income Tax Act (subject to a limit of Rs 1 lakh) but investments in ELSS schemes of mutual funds and 5 years bank fixed deposits, PPF, NPS are also eligible for exemption under the same section. Besides the premium, the maturity amount in ULIPs is also tax-free, irrespective of whether the investment was in a balanced or debt plan. Here, the debt fund option of ULIPs have an edge on debt mutual funds, as debt funds are taxed at 10% without indexation and 20% with indexation. The point to note, however, is that with the high charges of ULIPs despite its tax-efficiency the post-tax returns will be negative to low because of high front-end costs (in all probability debt fund of ULIPs will give a negative return even after 6 years). Debt mutual funds do not have such charges.
Banks (bancassurance) and insurance agents get high commissions for ULIPs, and they get them in the initial years, not staggered over the term like in traditional policies. So the insurer recovers most of the charges in the initial years. Insurers charges heavy marketing and distribution charges (read commission to agents), averaging more than 30% of the first year’s premium, and dropping down in subsequent years. The older products (2004-2005) had even higher charges. Compare this with mutual funds’ fees of 0% on entry, 0% on exit uniformly for all schemes.
As an illustration an agent (bank or otherwise) who sells you a ULIP may get 30% of your first year’s premium. If your annual premium is Rs 100,000 and the agent’s commission in the first year is 30%, it means only Rs 70000 of your money is invested in the first year effectively meaning a 30% return will make you gain break even status.
On the other hand, if you invest Rs 100,000 in an equity scheme with a 0% entry load, Rs 100,000 gets invested and if the market gives a 30% return your investment is worth Rs 130,000. This shows how ULIPs work out expensive for investors.
So what is the best way to mix the insurance and investment? Undoubtedly, a mixture of term insurance (very low cost and high cover) and mix of equity and debt mutual funds.
From the above illustration (assuming market grows by 30%) and one deducts the cost of a term policy from the mutual fund returns, one can still make a good return as compared to breaking even in case of an ULIP.
The insurance companies have now come up with a novel “Highest NAV Guaranteed” schemes in the market. These products too are nothing but making a fool of the gullible investors. Before buying these products keep these two points in mind:
1. Let us assume the premium paid is 100,000 and one is paying the premium for 3 years (these products have only 3 premium paying years unlike traditional ULIPs which are 10-15 years policies and one cat stop paying after 3 years). So the total premium paid is 300,000. Now assuming the insurance company charges a total of 40% as various charges over the 3 years, meaning only 180,000 gets invested and 120,000 is deducted as charges. So even with the “Highest NAV” the investor is unlikely to make much profits, in this illustration 40% growth of NAV is required only to break even.
2. The “Highest NAV Guarantee” is only valid if you survive the insurance policy period, if you do not, the nominee gets the basic cover which from the second year is generally 1.25-2 times the premium.
ULIPs thus are products which are in Unlimited Income Products for the insurance companies, banks (bancassurance) and agents.
4 comments:
I could not agree more...
Infact I was planning to do a post on this issue. But it would not have been so explicit
Keep it coming
Dear Sir,
I am an agent with LIC of INDIA. And I am telling you straight away that I am not writing here to promote ULIPs but make certain facts right. All the time the media talks bad about how much agents are paid in ULIPs, mis-selling,etc. But to tell you the fact, the commission under ULIPs for LIC is around 5-10% depending on the product. The renewal commission will be @ 2%. For single premium policies, which are getting sold mostly, the commission is just 2%. so where is the question of 30-40% commission. Also please be aware of the commission structure of MF agents: Even though the entry load is abolished, they still get around 0.5 - 0.6% from the AMC. Further more, the trail commission is @ 0.6% of the asset under management & not on the premium payable unlike in insurance. So as & when the years roll by, MF agent will be making more where as it starts declining for ULIPs. Please find the articles on the commission structure of MF & ULIPs (article from Business Line). Also please go through the article from DNA Money about SEBI's abolishing entry load & how it is harmful for the industry in the long run. there is much of hue & cry about agent's commission - when in every industry the profit margin is between 15-50%, it only makes sense to have such a kind in financial services industry too. Agreed, there is a lot of mis-selling by most of the agents - but curbing one's commission is not the right way to get rid of the issue. Making strict entry levels for becoming an insurance / investment advisor will ensure quality people in the industry & hence will avoid mis-selling in the long run. Also giving the client the freedom to switch advisors in case they are been provided proper service will ensure professional service too. As a salaried individual every one expects an increase every quarter & demand the highest salary. Why should any one be given higher salary - because that would anyways be increasing the cost to the company & hence its pricing in the market. So as a customer to that product, why should I pay more? because some person has to draw extra salary in their pockets. I hope it makes sense. Please donot get into the argument again as I am selling ULIPs more & all that. I am telling you again I have more term assurance clients than ULIP policy holders. Just wanted to share my thoughts from our side.
http://www.thehindubusinessline.com/2010/03/22/stories/2010032251570400.htm
http://www.dnaindia.com/money/comment_sebi-s-mutual-fund-norms-are-making-the-field-lopsided_1371854
Dear Mr. Annonymous,
Thank you for visiting my blog and giving your valuable time.
I dont know what commissions LIC is giving, I know what commissions private insurance companies are charging. I myself have a policy Tata-AIG InvestAssure II wherein more than 40% of my first year premium has been deducted as charges. (over the first 3 years they have taken almost 70% of 1 year premium as charges) I have a few frnds who have shown me similar charges on their policies by other private insurance companies.
MF agents are not supposed to get any commissions from the AMC now and the customers are supposed to pay the charges and if they are still giving it is illegal and you can definitely give the proff to SEBI and the AMC will be banned.
Finally, on an average I do recieve 3 calls per week, wherin it is pitched to me "we have launched a short-term investment plan" by one or other insurance company. This is misselling as ULIPS are not short-term insurance plans.
Yes, it is true that if someone holds ULIP for 10-12 years the cost with mutual fund will be more or less same. But my question would remain why do a insurance when the total premium paid is less than the cover?
For the long run (greater than 10 years) although both ULIP and MFs have same cost structure I guess MFs have more liquidity and transparency over ULIPs.
Finally, if ULIPs are not missold why more than 80% of insurer's (I am talking of the private players and not LIC) buisness comes from ULIP.
Last and the most important, the agents should get their money from the investor directly (as professional charge) and nobody is against the earnings of the agents. This way even the investor knows how much he paying for the services being rendered (same as in doctors, architects or any other professionals)
Oh, I almost forgot, Anonymous sir Market Plus I of LIC has a comission of greater than 25%, this is something that you forgot to mention.
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