It wasn't too long back, when the good old endowment plan was the preferred way to insure oneself against an eventuality and to set aside some savings to meet one's financial objectives. Then insurance was thrown open to the private sector. The result was the launch of a wide variety of insurance plans, including the ULIPs.
Two factors were responsible for the advent of ULIPs on the domestic insurance horizon. First was the arrival of private insurance companies on the domestic scene. ULIPs were one of the most significant innovations introduced by private insurers. The other factor that saw investors take to ULIPs was the decline of assured return endowment plans. Of course, the regulator -- IRDA (Insurance and Regulatory Development Authority) was instrumental in signalling the end of assured return plans.
Today, there is just one insurance plan from LIC (Life Insurance Corporation) -- Komal Jeevan -- that assures return to the policyholder.
These were the two factors most instrumental in marking the arrival of ULIPs, but another factor that has helped their cause is a booming stock market. While this now appears as one of the primary reasons for their popularity, we believe ULIPs have some fundamental positives like enhanced flexibility and merging of investment and insurance in a single entity that have really endeared them to individuals.
Given that ULIPs are relatively new and remain an enigma for a large section of insurance-seekers in this note we compare them to the traditional endowment plans to give you a perspective.
Sum assured
Perhaps the most fundamental difference between ULIPs and traditional endowment plans is in the concept of premium and sum assured.
When you want to take a traditional endowment plan, the question your agent will ask you is -- how much insurance cover do you need? Or in other words, what is the sum assured you are looking for? The premium is calculated based on the number you give your agent.
With a ULIP it works in reverse. When you opt for a ULIP, you will have to answer the question -- how much premium can you pay?
Depending on the premium amount you state, you are offered a sum assured as a multiple of the premium. For instance, if you are comfortable paying Rs 10,000 annual premium on your ULIP, the insurance company will offer you a sum assured of say 5 to 20 times the premium amount.
In our illustration your sum assured could vary from Rs 50,000 to Rs 200,000. Within this range, you have to decide how much insurance cover you need. Of course the multiple to calculate the sum assured varies across life insurance companies.
In the case of LIC's ULIP, the sum assured--premium relationship works the traditional way. So you need to state how much sum assured you are looking for and your premium is calculated as 1/10th the sum assured. If you have opted for a sum assured of Rs 100,000, your annual premium will be Rs 10,000.
Investments
Traditionally, endowment plans have invested in government securities, corporate bonds and the money market. They have shirked from investing in the stock markets, although there is a provision for the same.
However, for some time now, endowment plans have discarded their traditional outlook on investing and allocate about 10%-15% of monies to stocks. This percentage varies across life insurance companies.
ULIPs have no such constraints on their choice of investments. They invest across the board in stocks, government securities, corporate bonds and money market instruments. Of course, within a ULIP there are options wherein equity investments are capped.
Expenses
ULIPs are considered to be very expensive when compared to traditional endowment plans. This notion is rooted more in perception than reality. Let us take agent commissions to understand this better.
Sale of a traditional endowment plan fetches a commission of about 30% (of premium) in the first year and 60% (of premium) over the first five years. Then there is ongoing commission in the region of 5%.
Sale of a ULIP fetches a relatively lower commission ranging from as low as 5% to 30% of premium (depending on the insurance company) in the first 1-3 years. After the initial years, it stabilises at 1-3%. Unlike endowment plans, there are no IRDA regulations on ULIP commissions.
Mortality expenses for ULIPs and traditional endowment plans remain the same as also the administration charges.
One area where ULIPs prove to be more expensive than traditional endowment is in fund management. Since ULIPs have an equity component that needs to be managed actively, they incur fund management charges.
These charges fluctuate in the 0.80%-1.50% (of premium) range. We could not get a fix on the fund management charges of traditional endowment plans after having spoken to several insurance companies.
Flexibility
As we mentioned at the very beginning of this article, one aspect that gives ULIPs an edge over traditional endowment is flexibility. ULIPs offer a host of options to the individual based on his risk profile.
There are insurance companies that offer as many as five options within a ULIP with the equity component varying from zero to a maximum of 100%. You can select an option that best fits your objectives and risk-taking capacity.
Having selected an option, you still have the flexibility to switch to another option. Most insurance companies allow a number of free 'switches' in a year.
Another innovative feature with ULIPs is the 'top-up' facility. A top-up is a one-time additional investment in the ULIP over and above the annual premium. This feature works well when you have a surplus that you are looking to invest in a market-linked avenue, rather than stash away in a savings account or a fixed deposit.
ULIPs also have a facility that allows you to skip premiums after regular payment in the initial years. For instance, if you have paid your premiums religiously over the first three years, you can skip the fourth year's premium. The insurance company will make the necessary adjustments from your investment surplus to ensure the policy does not lapse.
We however recommend that you do not skip your premium payments. Remember, ultimately its your investment surplus that is being eroded with every skipped premium.
With traditional endowment, there are no investment options. You select the only option you have and must remain with it till maturity. There is also no concept of a top-up facility.
Your premium amount cannot be enhanced on a one-time basis and skipped premiums will result in your policy lapsing.
Transparency
ULIPs are also more transparent than traditional endowment plans. Since they are market-linked, there is a price per unit. This is the net asset value (NAV) that is declared on a daily basis. A simple calculation can tell you the value of your ULIP investments. Over time you know exactly how your ULIP has performed.
ULIPs also disclose their portfolios regularly. This gives you an idea of how your money is being managed. It also tells you whether or not your mutual fund and/or stock investments coincide with your ULIP investments. If they are, then you have the opportunity to do a rethink on your investment strategy across the board so as to ensure you are well diversified across investment avenues at all times.
With traditional endowment, there is no concept of a NAV. However, insurers do send you an annual statement of bonus declared during the year, which gives you an idea of how your insurance plan is performing.
Traditional endowment also does not have the practice of disclosing portfolios. But given that there are provisions that ensure a large chunk of the endowment portfolio is in high quality (AAA/sovereign rating) debt paper, disclosure of portfolios is likely to evoke little investor interest.
Liquidity
Another flexibility that ULIPs offer the individual is liquidity. Since ULIP investments are NAV-based it is possible to withdraw a portion of your investments before maturity. Of course, there is an initial lock-in period (3 years) after which the withdrawal is possible.
Traditional endowment has no provision for pre-mature withdrawal. You can surrender your policy, but you won't get everything you have earned on your policy in terms of premiums paid and bonuses earned. If you are clear that you will need money at regular intervals then it is recommended that you opt for money-back endowment.
Tax benefits
Taxation is one area where there is common ground between ULIPs and traditional endowment. Premiums in ULIPs as well as traditional endowment plans are eligible for tax benefits under Section 80C subject to a maximum limit of Rs 100,000. On the same lines, monies received on maturity on ULIPs and traditional endowment are tax-free under Section 10.Get started with your retirement planning. Click here!
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