The ULIP euphoria – is it justified?

ULIP is an abbreviation for Unit Linked Insurance Plan. Though ULIPs were around for years, US64 from UTI for instance. ULIPs became popular in India only after the insurance sector was thrown open to private players.

ULIPs has come to dominate the life insurance market in the recent past to such an extent that the initial euphoria is slowly turning into concern. It is worth analyzing the reasons behind the popularity of ULIPs among the public, life insurance agents and private insurers.

Understanding ULIP

A ULIP is a life  insurance policy which provides a combination of risk cover and investment.  The dynamics of the capital market have a direct bearing on the performance of  ULIPs.

Most insurers offer a wide range of funds to suit your investment objectives, risk profile and time horizons. Different funds have different risk profiles. The  potential for returns also varies from fund to fund.

The following are some of the common types of funds available along with an  indication of their risk characteristics.

General Description	Nature of Investments	Risk Category
Equity Funds	Primarily invested in company stocks with the general aim of capital appreciation	Medium to High
Income, Fixed Interest and Bond Funds	Invested in corporate bonds, government securities and other fixed income instruments	Medium
Cash Funds	Sometimes known as Money Market Funds – invested in cash, bank deposits and money market instruments	Low
Balanced Funds	Combining equity investment with fixed interest instruments	Medium

Investment returns from ULIP may not be guaranteed. Depending upon the performance of the unit linked fund chosen; the you may achieve gains or losses on your investments.

Charges, fees and deductions in a ULIP

ULIPs offered by different insurers have varying charge structures, further, insurers have the right to revise fees and charges over a period of time. Broadly, the different types of fees and charges applicable in a ULIP are given below.

1. Premium Allocation Charge : This is a percentage of the premium appropriated towards charges before allocating the units under the policy. This charge normally includes initial and renewal expenses apart from commission expenses.
2. Mortality Charges : These are charges to provide for the cost of insurance coverage under the plan.  Mortality charges depend on number of factors such as age, amount of coverage, state of health etc
3. Fund Management Fees : These are fees levied for management of the fund(s) and are deducted before arriving at the Net Asset Value (NAV) .
4. Policy/ Administration Charges : These are the fees for administration of the plan and levied by cancellation of  units. This could be flat throughout the policy term or vary at a pre-determined rate.
5. Surrender Charges : A surrender charge may be deducted for premature partial or full encashment of units wherever applicable, as mentioned in the policy conditions.
6. Fund Switching Charge : Generally a limited number of fund switches may be allowed each year without  charge, with subsequent switches, subject to a charge.
7. Service Tax Deductions : Before allotment of the units the applicable service tax is deducted from the risk  portion of the premium.

Investors may note, that the portion of the premium after deducting for all  charges and premium for risk cover is utilized for purchasing units.

Similarity of ULIPs with Mutual Funds

Are ULIPs similar to mutual funds? In structure, yes ULIP and Mutual Funds have great similarity; but in objective, both are different. Because of the high first-year charges in ULIP, mutual funds are a better option if you have a five-year horizon.

But if you have a horizon of 10 years or more, then ULIPs have an edge. To explain this further a ULIP has high first-year charges towards acquisition (including agents’ commissions).

As a result, ULIP find it difficult to outperform mutual funds in the first five years. But in the long-term, ULIP managers have several advantages over mutual fund managers. Since policyholder premiums come at regular intervals, investments can be planned out more evenly.

Mutual fund managers cannot take a similar long-term view because they have bulk investors who can move money in and out of schemes at short notice.

Insurance Companies prefer 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 the case of traditional products, the regulation prescribes that a life insurance company should maintain, at all times, a solvency margin reserve equal to 6 per cent of the liability plus an additional 0.45 per cent of the sum at risk. For unit linked policies, the reserve required is just 2 per cent of the liability plus 0.3 per cent of the sum at risk.

Since solvency margin requirements directly impact capital sufficiency, this is an additional reason for preferring unit linked products.

Further, 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 mobilize 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.

The ULIP Euphoria

The booming stock market has led the public to believe that ULIPs are the class of insurance policies that provides a safe and easy way to make money. No one pauses to think whether the high rate of rise in Stock Markets, witnessed during the bull run from year 2003 to 2008, can be sustained.

Insurance agents find it easy to push ULIPs to consumers. All they have to do is to assume that the recent high rate of increase will continue indefinitely. Even today when markets have corrected significantly, insurance agents are able to find new customers for ULIPs.

Its true that while judging unit linked policies, one has to take a long term view and not be unduly influenced by the present or immediate past. But the question is “Does the euporia surrounding ULIPs, justified?”