ULIP – Creates wealth for your distributor
One should never mix insurance and investment and stay away from "investing" in any of the product offered by insurance companies
ULIP is a hybrid product which is a combination of insurance and investment. In this article, I will explain why one should not mix insurance and investments and why taking a term plan for insurance and mutual funds for investments is a better option.
Let’s start with basic understanding of ULIPs, term plans and mutual funds.
When you pay the premium for a ULIP, a part of it is used for providing life cover, which obviously is not sufficient, and remaining is invested in market linked plans where investment risk is borne by the policyholder.
A pure term plan is just a risk cover, insured will not get anything in case he survives the policy period. In case of death of policy holder within the policy period, insurance company will pay sum insured.
Mutual fund is just a pool of investors money which is managed by professional fund management team as per the objective and mandate of the fund.
In a mutual fund, all the charges are summed together as Total Expense Ratio which a unit holder will pay, but charges in ULIPs are very complicated. There are multiple types of charges like Premium allocation charge, Policy administration charge, Fund Management Charge and Mortality Charge. In short, avoid what is opaque and complicated.
Insufficient Life Cover
Life cover in ULIPs is generally 10 times the annual premium. So, if someone is paying 2.5 lakh as annual premium, the sum insured in ULIP is just Rs 25 lakh. If this investor splits his ULIP premium and pay Rs 9-10,000 per annum towards insurance, he can get a pure life cover of Rs 1 crore, considering he is 30 years and non-smoker.
A person who is investing Rs 2.5 lakh per annum will be earning atleast Rs 7.5 lakh to Rs 10 lakh per annum (assuming saving rate between 25%-33%). Life Cover of Rs 25 lakh will be insufficient considering it will be close to only 2.5 times the annual income. Generally, financial planners recommend life cover of at least 10 times.
Commission
“The Great Commission is not an option to be considered; it is a command to be obeyed” – J. Hudson Taylor
ULIPs are generally sold by bank relationship managers and neighbourhood LIC Uncle as they have huge incentives to sell these products. It is their “Unit Linked Incentive Plan”. Commission in equity mutual funds are in the range of 0.85% to 1.25% per annum and there is no lock-in except for in few categories of schemes.
Commissions in ULIPs are much higher, I don’t have the exact numbers for this, but some of the ULIPs are offering 6% on first annual premium and 2% on subsequent premiums and renewals.
How has ULIP performed?
Performance of underlying funds in ULIPs is also as good as performance of schemes in mutual funds. But the big difference is, except for the fund management charge, which is accounted for in NAV of these ULIP schemes, rest of the charges are deducted by extinguishing the units.
This reason alone is more than enough for not comparing the performance of mutual fund schemes and underlying funds of ULIPs.
Conclusion
One should never mix insurance and investment and stay away from “investing” in any of the product offered by insurance companies. Insurance companies are best in underwriting risks and we should stick to utilise only this portion of their services. Pure term plan coupled with equity mutual funds should be opted to grow wealth.
(The writer is Chief Goal Planner, Money, Mind & Milestones. Views expressed are personal)