These products do not suit everyone even though they are flexible and facilitate investments in debt and equities.
Insurance industry, too, enjoys its flavours of the season. Earlier, endowment or moneyback policies were in vogue. And now the mantle seems to have been passed on to unit-linked insurance plans (Ulips).
The former, though, were easy to understand – you just keep paying the premium for the term and either get a lump sum payout or a specific amount at predetermined, regular intervals. There was nothing much to understand about the charges, as nothing was ever disclosed. This, however, changed with Ulips’ entry into the insurance scene. All charges were declared upfront and the product had unparalleled flexibility. And the question was asked repeatedly: are Ulips good investment vehicles?
The answer, though, cannot be a simple yes or no. As there is a lot that the consumer needs to understand before taking a decision.
If one were to compare the product simply on the returns front with other investment options, Ulips can outperform a combination of term insurance and actively managed mutual fund schemes, after 12-15 years.
If, instead of actively managed schemes, we consider index funds and index exchange-traded funds, then Ulips may never be able to outperform these. Besides the return factor, a host of factors may sway the decision one side or the other.
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Factor 1: In the case of Ulips, the investment for the entire tenure is going to a couple of funds available in the policy. Thus, there is a concentration risk. If the funds do not perform well for some reason, the entire portfolio will be adversely affected. The only recourse, then, is to exit the plan, which beats the purpose of investing for a particular goal. If investing through mutual funds or direct equity, one can always switch to better performing funds or exit loss-making scrips, fairly easily.
Factor 2: Suppose the funds are required in an emergency. In Ulips, you cannot access your ‘investment’ for the initial five years, that is you cannot take your funds out during this period. Even if one surrenders the policy, the amount will be made available only after the five-year period. This problem does not exist in the case of mutual fund schemes or direct equity.
Factor 3: Ulips work only if a client is willing to stay with the policy for the long-term. Investors may find themselves in a soup if they have entered the policy thinking that they will pay for five years and then cash out. This has been the spiel which many agents have used, giving Ulips a bad name. In case of such a churn, investors will lose badly. If investors have short to medium term horizons of upto 10 years, Ulips are not the products, one should look at.
Factor 4: For achieving a goal, regular investments are ideal. But in many cases, the required amount of money, say Rs 5,000 per month, may not be possible from year one. But even a much higher amount may become possible as one goes on and the goal may be possible to be achieved even by paying for a shorter duration. In Ulips, agents typically start a scheme with what is possible. After that, the review of the goal does not happen and further investments to meet the goal are not suggested.
This can be taken care of by the investor himself in two ways - one, top-up at regular intervals and, two, take further Ulips as one goes along. But as one goes along and opts for short-duration Ulips, then these may not be cost-effective, as seen earlier. Also, there are limits to top-up amounts - typically to the tune of the annual premium. Also, top-ups can be charged up to two per cent , even in the later years when premium allocation charges are nil.
Along with the why nots for investing in Ulips are also some factors that favour the instrument. First, you can switch between equity and debt funds many times in a year, without charge. Secondly, the investments made in debt funds are tax-free in Ulips. These two are clear advantages. And lastly, these products, specifically goal-related ones, are treated as long-term investments. This does not necessarily happen with direct equity investments or mutual funds.
So, who should invest in Ulips? The ideal candidate for the product is someone who has a long-term investment horizon and seeks simplicity in his investments. Also one must need the policy components. Otherwise it would be an unnecessary cost. The investor should be financially savvy as well to understand the product and take informed decisions. Else, it will simply seem like a maze, quite easy to get lost in!
The writer is a certified financial planner