Unit-linked insurance: All charged up

INSURANCE INVESTMENTS

ULIPs provide insurance cover with investment potential but they seem to charge more for bundling benefits.

What are ULIPs?
A unit linked insurance policy (ULIP) is one in which the customer is provided with a life insurance cover and the premium paid is invested in either debt or equity products or a combination of the two.

In other words, it enables the buyer to secure some protection for his family in the event of his untimely death and at the same time provides him an opportunity to earn a return on his premium paid.

In the event of the insured person's untimely death, his nominees would normally receive an amount that is the higher of the sum assured (insurance cover) or the value of the units (investments).

However, there are some schemes in which the policy holder receives the sum assured plus the value of the investments.

Every insurance company has four to five ULIPs with varying investment options, charges and conditions for withdrawals and surrender. Moreover, schemes have been tailored to suit different customer profiles and, in that sense, offer a great deal of choice.

The advantage of ULIP is that since the investments are made for long periods, the chances of earning a decent return are high.

Just as in the case of mutual funds, buyers who are risk averse can buy into debt schemes while those who have an appetite for risk can opt for balanced or equity schemes.

However, the charges paid in these schemes in terms of the entry load, administrative fees, underwriting fees, buying and selling charges and asset management charges are fairly high and vary from insurer to insurer in the quantum as also in the manner in which they are charged.

Tax benefits
The premiums paid for ULIPs are eligible for tax rebates under section 88 which allows a tax rebate of 20 per cent of premiums paid for taxable income below Rs 1.5 lakh and 15 per cent for income between Rs 1.5 and Rs 5 lakh.

Proceeds from ULIPs are tax-free under section 10(10D) unlike those from a mutual fund which attract capital gains tax.

Key features
Premiums paid can be single, regular or variable. The payment period too can be regular or variable. The risk cover (insurance cover) can be increased or decreased.

As in all insurance policies, the risk charge (mortality rate) varies with age. However, for an individual the risk charge is always based on the age of the policyholder in the year of commencement of the policy.

These charges are normally deducted on a monthly basis from the unit value. For instance, if there is an increase in the value of units due to market conditions, the sum at risk (sum assured less the value of investments) reduces and so the risk charges are lower.

The maturity benefit is not typically a fixed amount and the maturity period can be advanced (early withdrawal) or extended.

Investments can be made in gilt funds (government securities), balanced funds (part debt, part equity), money-market funds, growth funds (equities) or bonds (corporate bonds).

The policyholder can switch between schemes (for instance, balanced to debt or gilt to equity). The investment risk is transferred to the policyholder.

The maturity benefit is the net asset value of the units. The value would be high or low depending on the market conditions during the period of the policy and the performance of the fund manager.

Thus there is no capital protection on maturity unless the scheme specially provides for it. There could be policies that allow the policyholder to remain invested beyond the maturity period in the event of the maturity value not being satisfactory.

What you MUST ask your agent?
First-year charges: Usually, a minimum of 15 per cent. However, high premiums attract lower charges and vice versa. Charges can be as high as 50 per cent if the scheme affords a lot of flexibility.

Subsequent charges: Usually lower than first-year charges. However, some insurers charge higher fees in the initial years and lower them significantly in the subsequent years.

Administration charges: This ranges between Rs 15 per month to Rs 60 per month and is levied by cancellation of units.

Risk charges: The charges are broadly comparable across insurers.

Asset management fees: Fund management charges vary from 0.6 per cent to 0.75 per cent for a money market fund, and around 1.5 per cent for an equity-oriented scheme. Fund management expenses and the brokerage are built into the daily net asset value.

Switching charges: Some insurers allow four free switches in every year but link it to a minimum amount. Others allow just one free switch in each year and charge Rs 100 for every subsequent switch. Some insurers don't charge anything.

Top-ups: Usually attracts 1 per cent of the top-up amount. Top-up normally goes directly into your investment account (units) unless you specifically ask for an increase in the risk cover.

Surrender value of units: Insurers levy certain charges if the policy is surrendered prematurely. This levy varies between insurers and could be around 75 per cent in the first year, 60 per cent in the second year, 40 per cent in the third year and nil after the fourth year.

Fund performance: You could check out the performance of similar schemes (balanced with balanced; equity with equity) across insurance companies.

Look at NAV performance over a period of at least two to three years. This can only give you some indication about the credibility of the fund manager because past performance is no guarantee to future returns, especially in insurance products where the emphasis is on long-term performance (10 years or more).

What happens if you miss a premium? Does the policy provide for a grace period or does the policy lapse? Under what circumstances will the policy lapse? What are the exclusion clauses? Company policies on these points differ.

Here are some cardinal principles you need to follow when you buy insurance. Since an insurance agent is permitted to sell only one insurance company's policies it is advisable to meet agents from different companies. That would help you compare schemes across companies.

Since insurance is a product which entails a long-term commitment on the part of the insurer, it is important not to go only by the features or the cost advantages of schemes but by the parentage of the insurer as well.

Comparing schemes based on costs is a fairly complex exercise. As a rule, the higher the initial years' expenses the longer it takes for the policy to outperform its peers with low initial years' costs and slightly higher subsequent year expenses. 

Retire unhurt

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Pension plans are essentially tailored to meet old age financial requirements. But there are certain advantages in joining a pension plan.

First of all, contribution to pension funds upto Rs 10,000 is eligible for tax deduction under section 80CCC. In other words, your pension contribution will get deducted from your taxable income.

So if you are in the top tax bracket, liable to pay to a 30.6 per cent tax, then your tax savings will be that much.

All life insurance companies offer pension products - both conventional and unit-linked. In both cases you pay a certain premium amount for a specified length of time.

Usually, the minimum entry age is 18 years and the maximum age is 60 years. You can choose to pay the premium for five to 30 years. When the policy matures, you receive one-third of the value of the accumulated amount as a lump-sum payment.

For the remaining, you can buy annuities either from the existing insurer or any other insurer.

While in a conventional scheme, your money is managed through the insurer's pooled investment account and you are entitled to bonuses every year, in a ULIP you receive the value of the investment in your individual account.

In a ULIP you have the flexibility to choose between a conservative scheme or an aggressive scheme with high allocation to equities. Pension policy impose huge penalties for early termination.

Most pension plans provides for four annuity options - (1) annuity for life, (2) annuity payable for a chosen term and for life thereafter, (3) annuity for life with return of purchase price on death to the beneficiary and (4) annuity for life to you and then to your spouse with return of purchase price to the beneficiary on death of last survivor - which can be exercised at any time within six months of the vesting date or the date on which you are eligible for pension. Schemes allow postponements of vesting age and also early retirement.

 

How does ULIP work ?

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Rahul is a thirty-year old who wants a product that will give him market-linked returns as well as a life cover. He wants to invest Rs 50,000 a year for 10 years in an equity-based scheme. Based on this premium, the sum assured works out to Rs 5,32,000, the exact amount of premium being Rs 50,032.

Based on the current NAV of the plan that Rahul chooses to invest in, he is allotted units in the scheme. Then, units equivalent to the charges are deducted from his portfolio.

The charges in the first year include a 14 per cent sales charge, an administration charge (7 per cent for the first Rs 20,000 and 3 per cent for the remaining Rs 30,000) and underwriting charges which are deducted monthly.

Besides, mortality charges or the charges for the life cover are also deducted. For the remaining nine years a 3.5 per cent sales charge and an administrative charge of 4 per cent (for the first Rs 20,000 and 2 per cent for the remaining Rs 30,000) are levied in addition to mortality charges.

Fund management fee of 1.5 per cent (equity) and brokerage are also charged. This cost is built into the calculation of net asset value.

On maturity - that is, after 10 years - Rahul would receive the sum assured of Rs 5,32,000 or the market value of the units whichever is higher.

Assuming the growth rate in the market value of the units to be 6 per cent per annum Rahul would receive Rs 5,81,500; assuming the growth rate in the market value of the units to be 10 per cent, Rahul would receive Rs 7,24,400.

In case of Rahul's untimely death at the end of the ninth year, his beneficiaries would receive the sum assured of Rs 5,32,000 or the market value of the units whichever is higher. Assuming the growth rate in the market value of units is 6 per cent per annum, the value of investment would be Rs 5,10,200.

However, his family will get Rs 5,32,000 as it is the sum assured.

Assuming a growth rate of 10 per cent per annum, the value of units at the end of the ninth year would be Rs 6,21,900. Hence, the beneficiaries would get Rs 6,21,900.