Unit Linked Insurance Products or Unlimited Income Products for the insurance companies, banks (bancassurance) and agents

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.

Buy and Hold versus Swing Trading

What is a Buy and Hold strategy: Buy and Hold is a passive form of investment strategy wherein one buys stocks and holds them for a long period of time (multiple years), regardless of market price (fluctuations in the market).

An investor who believes and follows this strategy, selects his stocks actively, but once a position has been taken is not concerned with the market gyrations or the technical indicators.

The Buy and Hold was considered one of the best strategies and widely believed to give the best results on the long run. The buy and hold strategy even today might be one of the better strategies but only if the portfolio is substantially big (more than 15 stocks).

Pros of the strategy:
Buy and Hold strategy has broadly the following benefits:
Low on stress: By trading (actively buying and selling) fewer stocks and not looking at the price tickers on an hour-to-hour basis, it is easier on the heart (read less of BP and heart attacks) of an investor.

Taxes: Since Buy and Hold strategies often call for a time horizon greater than 1 year, the rate of tax is much lower.

Brokerage and commissions: Active trading can prove costly. Traders can ultimately pay commissions (brokerages) and government duties in the tens of thousands rupees each year. A Buy and Hold strategy can allow an investor to invest large sums of money with minimal costs (as brokerage and duties are paid only once and over a long period of time).

Cons of the strategy:
The Buy and Hold strategy may give the appearance of a safer investment model, but like any other strategy it is fraught with risks. The buy and hold killer can be bear markets. If a buy and hold investor purchases a stock prior to a market decline similar to the ones in 2002 and 2008, the investor may have to wait 5-10 years to make any returns on their initial investment. The most bitter note for the buy and hold strategy is that you have to buy and hold (for multiple years) and thus no realized profits. Finally, remember Dow Jones has done nothing over the last 10 years (11,722.98 January 14, 2000, to 10,325 on February 26, 2010) meaning over a period of 10 years investors invested on Dow Jones have made a net loss (plus inflation).

Consider these:

COMPANY PRICE ON Feb 26, 2010 PRICE ON February 26, 2009 CHANGE (%)
BSE-SENSEX 16,429.55 8,954.86 83.5%
S&P CNX NIFTY 4,922.30 2,785.65 76.7%
STERLING BIOTECH 8.45 152.95 -35.6%
TATA COMM. 282.55 408.00 -30.7%
SPICE COMMU 57.30 76.05 -24.7%
KOUTONS RETAIL 353.90 448.20 -21%
BHARTI AIRTEL 279.25 325.90 - 14.3%
HIND. UNILEVER 235.75 253.05 - 6.8%
RELIANCE COMM 157.35 158.90 -1.0%

The above stocks shows that blue chip companies like Bharti and Hindustan Unilever can also give negative returns when the overall market has given 83% return for the same period. Worse still would have been the result on a buy and hold strategy investor who had invested his money in 2007 and early 2008 (portfolio likely to be marginally positive or negative).

What is swing trading: This is a style of trading that attempts to capture gains in a stock within a short period of time. Swing traders use technical analysis to look for stocks with short-term price fluctuation. These traders are interested in the price trends and patterns more than fundamental value of the underlying stock.

The nifty has been moving in a range for the last few months (generally between 4700 and 4950). Swing trading involves buying at the lower levels and selling near the higher levels.

Pros of this strategy: Swing trading strategy has broadly the following benefits:
1. Profits: The trader/investor gets quick potential profits without the need to watch the price tickers on a minute-to-minute basis. It is a great strategy for traders who hold a full time job doing something else and can't follow the market on an every second basis. Since swing traders stick with a stock for several days and sometimes a week or more, the transactions are lower and hence less commissions (brokerage) and government duties. Swing trades can be done on the downside also (i.e., selling short) and thus volatility can be used to one’s benefit.

Cons of this strategy:
1. Loss: The swing trades might go wrong, i.e., the previous range can break up or breakdown, so the trader needs to keep stop loss for each of his trades and thus can make limited loss (extent to the stop loss), although the profit can be unlimited.

While both of the above strategies have their advantages, the Buy and Hold strategy will give best results only when one has a bigger corpus and multiple stocks, so that the laggards can be compensated by the leaders and the portfolio give a better result. The swing trading strategy is for more active traders (less active than daily traders) and can give higher percentage yields over the longterm (when the trades are done in conjunction with technical analysis).

Power Ke Liye Kuch Bhi Karega

A democratic government means a government by the people; a form of government in which the supreme power is vested in the people and exercised by their elected representatives under a free electoral system. The representatives are elected on the basis of their party’s ideology or in some cases without any party affiliation (independents).

A political party is an organization that seeks to gain political power and form a government by participating in elections. Parties often adopt an expressed ideology or vision reinforced by a written manifesto with specific goals.

India has around half a dozen national parties and 100s of regional parties that are all fighting amongst themselves to represent Indians in the parliament.

Today, (May 13, 2009) the last day of voting for the 15th Lok Sabha is coming to an end and India has elected its representative for the 15th Lok Sabha (although results are yet to come out). The early projections which are coming from the media indicates that we are going to have another hung parliament and thus no political party or pre-poll alliance will get the mandate to govern.

In this election ideologies of all political parties are set to be thrown out of the window and every sort of combination is possible to grab power (barring perhaps BJP and Left, Congress and BJP, and BJP and Indian Union Muslim League) or perhaps Power Ke Liye Kuch Bhi Karega.

If indeed this is true and the post-poll alliances like Congress led UPA is supported by the Left front again, does voting really matters? The MPs from Left Front predominantly comes from the states of West Bengal, Kerala, and Tripura. In all these three states, Left Front and Congress are the principal opposition, either alone or in alliance. How does the mandate of the people matter if these two parties come together? A person voting against Left will feel cheated if the Congress forms an alliance with the Left and similarly a person voting against Congress will feel cheated if the Left supports Congress.

In Bihar, NDA (BJP and JDU), Congress and the Yadav Front (Laloo, Paswan and Mulayam) are fighting against each other. In this state also there are talks of party's crossing over and thus making the process of going to the people redundant.

Same is in the case of Uttar Pradesh where BJP, BSP, Congress, SP are fighting each other and post-poll BSP and SP might go to support either of the 2 alliances (UPA or NDA). Now the voters have every right to feel cheated as their votes really does not matter.

Tamil Nadu presents another peculiar situation where the Congress and DMK are pre-poll partners and AIDMK is the main opposition. The DMK is going to do badly in the elections, if the media reports are to be believed, and there are talks of both BJP and Congress making an attempt to woo AIDMK. If the Congress succeeds in getting AIDMK under its fold and dumping DMK then does the voter matter?

I think India should move to a 2 coalition formation politics and anti-defection law should come into force if any pre-poll alliance party crosses over to another formation post-poll. Otherwise, the entire process of voting becomes an unnecessary exercise where millions of rupees are wasted and many of our policemen and paramilitary men have to make the supreme sacrifice in the Naxal belts and other poll related violence, and yet the mandate of people is manipulated by the political parties to bring themselves into power.