For SCMHRD: Insurance Management

Note on ULIPs.

ULIP

What is ULIP ?
ULIP or Unit Linked Insurance Plan is a mix of insurance along with investment. From a ULIP,
the goal is to provide wealth creation along with life cover where the insurance company
puts a portion of your investment towards life insurance and rest into a fund that is based on
equity or debt or both and matches with your long-term goals. These goals could be
retirement planning, children’s education or another important event you may wish to save
for.

ULIP is a combination of insurance and investment. Here policyholder can pay a premium
monthly or annually. A small amount of the premium goes to secure life insurance and rest of
the money is invested just like a mutual fund does. Policyholder goes on investing through
the term of the policy – 5,10 or 15 years and accumulates the units. ULIP offers investors
options that invest in equity and debt. An aggressive investor can pick equity oriented fund
option whereas a conservative one can go with debt option. “If you have a long term ULIP, go
for equity oriented fund option – which is called a growth option,” says Deepak Yohannan, CEO
of myinsuranceclub.com.

He further points out that the recently launched ULIP are better than the older ULIP due to
lower charges. One can pick and choose the low cost ULIP. While traditional insurance plans
offer 4% to 6% returns, ULIP can offer you double digit returns if you are invested in equity
funds, says Deepak Yohannan.

How does ULIP work?

When you make an investment in ULIP, the insurance company invests part of the premium
in shares/bonds etc., and the balance amount is utilized in providing an insurance cover.
There are fund managers in the insurance companies who manage the investments and
therefore the investor is spared the hassle of tracking the investments. ULIPS allow you to
switch your portfolio between debt and equity based on your risk appetite as well as your
knowledge of the market’s performance. Benefits like these which offer investors the
flexibility of switching is a huge factor contributing to the popularity of these investment
instruments.

Lock-in-period of ULIP
One of the changes brought about by the Insurance Regulatory and Development Authority
of India (IRDAI) in the year 2010 as regards ULIPs, was to increase the lock in a period from 3
years to 5 years. However, insurance being a long-term product, as an investor you may not
really reap the benefit of the policy unless you hold it for the entire term of the policy which
can range from 10 to 15 years.
Benefits of ULIP

 Life cover: First and foremost, with ULIPs you get a life cover coupled with
investment. It offers security that a taxpayer’s family can fall back on in case of
emergencies like the untimely death of the taxpayer, etc.
 Income tax benefits: Not many are aware that the premium paid towards a ULIP is
eligible for a tax deduction under Section 80C. Additionally, the returns out of the
policy on maturity are exempt from income tax under Section 10(10D) of the Income-
tax Act. This is a dual benefit that you can claim with this policy
 Finance Long Term Goals: If you have long-term goals like buying a house, a new car,
marriage, etc., then ULIP is a good investment option because the money gets
compounded. As a result, the net returns are generally more. This stands true even if
you want to exit after the 5 year lock-in period in comparison to not having invested
the amount at all and retaining it in a savings account or in the form of an FD. But,
under ULIP, the mantra is to always keep the policy going for a longer time horizon to
reap the best out of it
 The flexibility of a portfolio switch: As already mentioned, ULIPS are usually designed
in a way that they allow you to switch your portfolio between debt and equity based
on your risk appetite as well as your knowledge of how the market is performing.
Insurance companies, on the other hand, allow a very few numbers of switches free
of cost

Things to consider as an investor

Following are some important factors you should weigh in before investing in ULIPs:

 Personal financial goals: If your financial goal is about wealth creation and you want
to save money for retirement, ULIP is one of the best options available.
 Compare ULIP offerings: Once you have determined your financial goal and the type
of ULIP that will help you achieve it, the next step would be to compare the ULIP
offerings in the market. Look for a comparison in the form of background expenses,
premium payments, ULIP performance, etc. Also, investigate the nature of funds that
the ULIP invests in to ascertain the returns from investments in the particular ULIP
 Risk factor: Since ULIP investment is not as diversified as compared to ELSS, the risk in
ULIP is probably a bit high compared to schemes like ELSS
 Investment horizon: ULIPs have a lock-in period of 5 years. If a ULIP is surrendered in
the first three years, the insurance cover would cease immediately. However, the
surrender value can be paid only after three years
Types of ULIPs
ULIPs are categorized based on the following broad parameters:

a. Funds that ULIPs invest in

i. Equity Funds: Where the premium paid is invested in the equity market and thereby is
subject to higher risk
ii. Balanced funds: Where the premium paid is balanced between the debt and the equity
market to minimise the risk for investors
iii. Debt Funds: Where the premium is invested in debt instruments which carry a lower risk
but in turn also offer a lower return

b. End use of Funds

i. Retirement Planning: For those of you who plan to invest for the retirement days while
you are still employed
ii. Child Education: You can investment with a long-term goal of saving to fund your child’s
education or save for some unforeseen circumstances
iii. Wealth Creation: You can make investments to build a heavy corpus that you can utilize
for a future financial goal

c. Death benefit to Policy Holders

i. Type I ULIP: This pays higher of the assured sum value or the fund value to the nominee in
case of death of the policyholder
ii. Type II ULIP: This pays the assured sum value, plus the fund value to the nominee in case
of the death of the policyholder

7. ULIPs Vs Mutual Funds

Here is a comparison between the two:
Particulars ULIPs Mutual Funds

Nature Investment cum Pure Investment product

insurance product

Withdrawal Only after lock-in- Can be withdrawn

period of 5 years anytime

Switching Alternating between Switching is permitted

funds is permitted and between schemes of the
not subject to same fund house.
taxation. However, it’s treated as a
redemption and the
 resulting capital gains are
taxable.

Charges Mortality charges, No entry load, the annual

premium allocation fund management
charge, fund charges apply and an exit
management charge load, if applicable.
and administration
charges

Income Tax Benefits

Premium paid on ULIPs is eligible for a deduction under Section 80C up to a maximum of Rs
1.5 lakhs during a year. Further, the amount you receive on maturity is tax exempt under
Section 10(10D).

Types of fees and charges

In every investment, there are various charges that need to be paid. In the case of ULIP, the
charges can be broadly classified as:

a. Premium Allocation Charge

Premium Allocation Charge is deducted as a fixed percentage from the premium paid in the
initial years of the policy. This is charged at a higher rate. The charges include the initial and
renewal expenses and intermediary commission expenses. It is a front load charge as it is
deducted from your premium paid.

b. Mortality Charges
This charge is to provide for the insurance coverage under the plan. Mortality charges
depend on a number of factors like age, sum assured, etc., and is deducted on a monthly
basis.

c. Fund Management Charges

Fund Management Charge is the fee imposed by the insurance company for the
management of the various funds in the ULIP. It is levied for the management of the funds
and is deducted before arriving at the NAV figure. The maximum charge allowed is 1.35
percent per annum of the fund value and is charged daily. Generally, insurers levy the
maximum amount allowed in equity funds, while the charge on non-equity funds is much
lower.

d. Partial Withdrawal Charge

ULIPs have the option of partial withdrawals of funds. Some plans offer unlimited
withdrawals, but some restrict it to 2-4 withdrawals. These withdrawals can be free for up to
a certain limit or you can be charged based on your transactions.
e. Switching your funds
The moving of funds or investments between options is called switching. There are options
to switch your funds for free up to a certain limit per year. Any further changes might incur a
charge of Rs. 100 -Rs.250 per switch.

f. Policy administration charges

This charge is levied for the administration of the policy and it is deducted on a monthly
basis by the cancellation of units from all funds chosen. This charge can be levied at a fixed
rate or as a percentage of your premium. ULIP as a mode of investment is a good choice
given it offers the benefits of insurance with investment. With part of the investment spread
across stock markets, you stand to gain higher returns. This also means that your investment
is subjected to market risks. If your risk profile meets the tradeoff, this could be worth
exploring.

ULIP’s —Type 1 Or Type 2?S

ULIP's ostensibly combine "insurance and investments" into a single product that solves both
purposes (a debatable claim, mind you!). What this essentially means is that the premiums
that you pay (post the deduction of commissions paid to your agent) are divvied up between
the pool of money that serves to pay death claims, and the pool of money that is invested
into securities such as stocks and bonds. Intuitively, the allocation to the former pool will be
higher if the sum assured is higher. For instance, the portion of your ULIP premium that goes
towards covering risk will be a lot more if your sum assured is Rs. 50 lakhs than if your sum
assured is Rs. 5 lakhs.

Here's where the difference between Type 1 and Type 2 ULIP's come in. Type 1 policies will pay
your dependents the higher of the sum assured and your accumulated fund value, in case of
your unfortunate death. Type 2 policies, on the other hand, will pay out the sum assured PLUS
the accumulated fund value in such an event.

Mired in confusion? An example could prove handy at this stage. Let's say you've purchased a
ULIP with an annual premium of Rs. 5 lakhs, which has an appended sum assured of Rs. 50
lakhs. If this is a Type 1 ULIP, the death benefit will remain constant at Rs. 50 lakhs till the
point that your fund value overtakes the sum assured - at which stage, the death benefit
becomes the fund value itself. For instance, if your fund value is Rs. 60 lakhs at the end of 8
years, the insurance company will be bearing no risk at all, since the payout will be equal to
the funds that are already accumulated, paid up and held in your name.

For Type 1 ULIP's, the 'value at risk' for the insurance company drops a notch with each passing
year and with each subsequent premium payment made by you. For instance, after the first
premium payment (assuming a 10% deduction of charges), the value at risk for the insurance
company will be Rs. 50 lakhs minus Rs. 4.6 lakhs, or Rs. 45.4 lakhs. After the second premium
payment of Rs 5 lakhs, the value at risk will drop by another 5 lakhs, and so on.

As the value at risk for the insurer drops, so does the mortality cost, or the cost of
transferring the financial risk of your loss of life to the insurer. Many hapless ULIP buyers
aren't even aware that each year, this mortality cost is deducted from their fund value as
cancelled units! Only when they scrutinize their statements do they realize this. (Check your
last statement quickly if this is you)

Because the number of units getting deducted in lieu of mortality costs drops year on year in
Type 1 ULIP's, the actual quantum of money that finds its way into the investment pool is
higher - which is why they have a higher chance of providing you with a higher fund value at
the end of the ULIP term.

For Type 2 ULIP's, on the other hand, the value at risk for the insurance company does not go
down with time, as they will be paying your nominee the sum assured PLUS the accumulated
fund value in the unfortunate event of your death. If anything, it goes up with each passing
year, as the probability of dying goes up with every passing year (sorry to put it so crudely,
but that's how insurance companies view it!).

Going back to our previous example, if your accumulated fund value is Rs. 60 lakhs at the end
of 8 years, the death payout in case of a Type-2 ULIP will be Rs. 60 lakhs plus the sum assured
of Rs 50 lakhs, or Rs. 1.10 crores (compared to 60 lakhs for a Type 2 ULIP). However - the final
fund value will naturally be a lot lower, because the cost of providing the additional death
benefit of Rs 50 lakhs will continue to get deducted from your kitty year on year.

End Note: As is the case ever so often with financial instruments, there's no 'one size fits all'
answer to which variant, product or solution is best for you. Your decision must hinge on
your unique financial priorities and money goals. For purely providing you a better death
benefit (the actual purpose of insuring your life, which is so inconveniently forgotten by
most), Type 2 policies score. For creating more wealth, Type 1 ULIP's work better. As a purist,
I would opt for the Type 2 variant, since it makes for a better risk transfer tool. Some may beg
to differ.

These are hybrid products that mix life insurance and investments. Like any other life
insurance product, these offer life cover along with investment. However, it is left to the
policyholder to make the investment choice from the available fund option, thereby
transferring the risk of investment to the policyholder. Funds can be equity oriented, debt
oriented or a combination of both. Though, these policies can be more profitable than a
traditional insurance policy; it also has a higher risk.

Capital Protection and Inflation Protection-

The sum assured in a life insurance policy is guaranteed as per the terms of the policy as long
as the premiums are paid and the policy is in force. Life insurance is not inflation protected
because insurance is a fixed cover-fixed tenure product, wherein the sum assured is fixed.
However, the equity fund option has all the potential to beat inflation and create wealth over
the long-term. But it does not guarantee inflation beating returns.
 Guarantees-
The minimum sum assured/death benefit is guaranteed and the premium is fixed for the
tenure of the policy. Returns on the investment portion are market-linked and hence not
guaranteed.

Liquidity-
ULIPs are liquid only after the lock-in period of five years. This is achieved by redeeming units
in which the premiums are invested in. One can also make premature withdrawal or
surrender the policy at a loss. Loans are available against the policy depending on the policy
type, the years it has been in force, its sum assured or the fund value at the time of seeking
loan.

Exit Option
One can surrender or terminate the policy at a financial loss.

 The insurer will credit and refund the proceeds of the discontinued policy to the policyholder
only on completion of the lock-in period.
 The proceeds of the discontinued policy for the purpose of refund to the policyholder shall
mean the fund value on the date of discontinuance plus interest computed at a minimum
rate of 4 per cent per annum.

Tax Implications-
Premiums paid towards a life insurance policy qualify for tax deductions under Section 80C
with a limit of Rs 1.5 lakh in a financial year. If the premium paid exceeds 20 per cent of the
sum assured of the life insurance policy, the amount eligible for tax deduction under section
80C will be limited to 20 per cent of the sum assured. For policies issued on or after 1.4.2012,
the above mentioned limit of 20 per cent has been changed to 10 per cent. The proceeds
from the maturity or claims on a life insurance policy are exempt under Section 10(10D).

Types of ULIPs
There are broadly three types of ULIPs that are based on the benefits they offer and are
classified as Type I, Type II and Pension ULIPs (ULPPs).

Type I ULIP: In this plan on death of the policyholder the policy pays the higher of the sum
assured or the unit value of the investment to nominees.

Type II ULIP: In these plans on death of the policyholder the policy pays out both the sum
assured and the net asset value of the fund the policyholder invested in to nominees.
Premiums on such plans are higher than those on Type I ULIPs and as investments come at a
high level of risk, you shouldn't abandon your policy in the early years.

Pension ULIPs: This type of ULIP combines life insurance and retirement income. The part of
this insurance that relates to life coverage is similar to Types I and II: Upon death, the insurer
pays the nominees the death benefit; if you live to retirement age, this pension plan pay back
the premiums and accrued returns to you in full to buy an annuity.

Points to Ponder:

Possible questions in the class-room for discussion.

1. What is the future of ULIP?

2. Do the tax rates and changes in the Finance Bill and the Union Budget which will
be announced on February 1,2019 impact the ULIP policy proposals?
3. What would be your recommendations to the Finance Minister for the Insurance
Sector in general as well as ULIPs in particular.
4. Would you be interested in investing in a ULIP policy?
5. What is the benefit if the policy Is continued for a long-term?
6. Equity investments as a class generates better returns in the short-term or the
long-term. Discuss.