Moneymanagement’s Weblog

Life insurance beyond ULIPs

Posted in insurance by moneymanagement on July 7, 2009

Every single individual who is married, owns a business, has dependent children or parents, has major financial obligations and should have a life insurance plan in his portfolio. Planning for Life Insurance cover is based on a number of factors like an individual’s life stage, personal priorities, number of dependants, child’s education/ marriage, retirement needs, loan liabilities, etc.

The ideal combination of insurance products is best explained in a pyramid of insurance needs. An individual who has dependents on him must look at a policy that covers life for a substantial amount at a very competitive / low price like a pure Term plan. The general thumb rule is 10-20 times one’s annual income. Many do not realize that term assurance plans are the most affordable insurance products to protect the family against financial consequences of death. It could be used to replace the loss of income, to face repayment of a loan liability. Term assurance product will not replace the loss of the loved ones but helps reduce the monetary burdens of the family by providing immediate lump sum money without any hassles. This gives an extended time frame for the family members to take any important financial decision.

However, when you contact your friendly neighbourhood insurance agent to agent your insurance cover, he is sure to recommend ULIPs as the ‘most popular option’. Unit Linked Insurance Plans (ULIPs) have become the flavour of the season. One of the main reasons that ULIPs get so push from agents and insurers alike is that these are high ticket items for them. The agent earns a percentage of the premium paid and since the premium of a ULP is several times that of a simple term plan, you will not find a single agent suggesting a term plan as an attractive option

ULIPs are often mis-sold by offering attractive returns and comparing them to mutual funds that offer insurance. However, it is imperative for you to know how to calculate the real returns generated by the ‘savings portion’ of a ULIP. Here are a few guidelines to help you…

Components of a ULIP

There are two components to a ULIP – the protection component and the savings component. The protection element is the underlying insurance cover while the savings element is that portion of the premium that is invested by the insurance company on your behalf in an investment fund of your choice. There are generally 3-6 investment funds on offer, each carrying a different debt to equity ratio and therefore varying amount of risk.

Quantum of Premium Invested: It is a misconception, that the entire premium that you pay is invested on your behalf by the insurance company in an investment fund of your choice. There are several costs that are deducted from the premium that you pay and only the residual is invested. The various costs that are deducted are:

Mortality Charges: These are charges that are deducted as a payment towards the risk cover that the protection element of your ULIP offers. While mortality charges are the same for across companies, the other charges differ

Administration and Sales Charges: These are operational and marketing costs and are largely made up of the agent’s commission.

Over and above these charges, your investment fund also attracts ‘fund management’ charges. These are charges that are levied by the insurance company for making and managing the investments on your behalf. These charges vary from each fund-type. For instance, a fund which has a greater exposure towards equity will attract a larger fund management fee than a fund that has zero equity exposure. These charges are deducted directly from your investment fund on a daily basis.

Details of all these charges will be mentioned in the policy document and in the premium payment receipts and they will vary from company to company. Jayant Khosla, MD & CEO for Future Generali Life Insurance Company Ltd. Explains “Mortality charge in Future Sanjeevani (a ULIP) per thousand for 30 yr male is Rs 1.06 and remaining charges are very competitive. Our FMC ranges from 1.10% to 1.50%, Premium allocation charge in First year is as high as 10%. Policy admin charges are Rs75 per month”

If you are a 30 year old buying a term insurance plan of Rs25 lacs for a period 10 year then you would pay an annual premium of Rs5,475/- One could consider this a basic mortality and administration cost.

The ULIP cost are hidden behind a multitude of figures. Usually the agent will ask you to tell him the premium you can pay and then calculate the life insurance for you. So you may actai=ully end up being under insured.

Where are the returns?

In order to evaluate the returns that are generated by a ULIP, you need to take into consideration only that portion of the premium that is invested on your behalf in the investment fund. The growth has to be calculated on this portion from which units are purchased on your behalf at the current NAV every time you pay your premium.

The catch in calculating returns is that often companies deduct ULIP charges of the entire policy period in the first few years. Hence you may see that for the first 3 years or so nearly 70 per cent of the premium you pay has gone towards paying a multitude of charges and only 30 per cent is invested. In the later years a higher amount is invested however this sort of investment pattern followed by many insurance companies is a lose-lose situation in two ways:

you lose out in the compounding of your investment since a small amount is invested initially

if you wish for an early withdrawal, you lose all around since your premiums have not yet be invested fully to get a fair chance to grow.

One often calculates the appriciation of ULIP in terms of increase of decrease in the net asset value (NAV), The NAV of ULIPs is not the real indicator of the actual returns earned on your investment. The various charges on your policy are deducted either directly from premiums before investing in units or collected on a monthly basis by deducting the units you own.

Either way, the charges do not affect the NAV; but the number of units in your account fall. You might have access to daily NAVs but your real returns may be substantially lower.

A rough calculation shows that if your investments earn a 12 per cent annualised return over a 20-year period in a growth fund, when measured by the change in NAV, the real pre- tax returns might be only 9 per cent. The shorter the term, the lower the real returns.

Understanding the policy account statement

Your policy account statement is the key to understanding the returns on your ULIPs. It includes

  • The premium you have paid for the year.
  • Policy loading fees.
  • Sales charges – usually in the first year.
  • Monthly deduction of insurance and administration fees which takes place by way of cancellation of units
  • The total number of units you currently own and its current NAV.

The statement of accounts is obscure and incomprehensible in many ways. It does not give a break up of how many units you owned in the previous year and at what rate nor does it give details about how many units were added on this year. Ofcourse if you wish to know the details you can take out your previous documents and play around with your calculator. Without base information of the previous years it is very difficult to calculate the returns on your policy.

ULIPs in a Bear Market

  • In today’s market conditions equity oriented ULIPs are likely to give you negative returns in the short to medium term.  The USP of ULIPs has always been high returns which have evaporated now.
  • ULIPs however do offer you a lot of flexibility in terms of increasing and decreasing investments and changing your risk profile as your life and the market conditions change. Your risk appetite and investment objectives will mirror the different stages of your life. Therefore, it is imperative that you rebalance your asset allocation plans to ensure that there is synergy between the two. Investors should always remember that investment fund options are designed not to encourage speculation in the market but to facilitate selection of a fund option that fits an individual’s risk profile and time horizon.
  • Use ULIPs as Systematic Investment Plans (SIPs) to offset market volatility and negate the need of timing the market. Invest a fixed amount of money in the same investment option at regular intervals. Therefore, you will automatically be entitled to more units of the investment fund when the prices of the underlying assets are low and more units when the prices are high.

For most of us it is best to separate out insurance and investment avenues. Term insurance is by far the most economical way to get insured. Bundling up the two may prove to be too heavy for the pocket