Insurance Basics Part IV - Unit Linked Insurance Plan - ULIP

By Prajna Capial

Understanding the cost structure of Unit Linked Insurance Plan is necessary before taking the leap

A person, 40-year-old investor, was disgruntled with his investments in Unit-Linked Insurance Plan (ULIP). While the equity markets have been rolling, he realized after some research that he was yet to recover the money he had invested three years ago. This, he realized, was not on account of poor fund performance but because of higher initial fund costs. While the people crib is about the non intimation of such expenses by his/her broker, insurance regulator IRDA has come to his rescue, making it mandatory to disclose all charges upfront to the buyers.

Basic rules have to understand the cost structure of a fund before buying into ULIPs. And a basic understanding would save them from heartburn. So how are the cost structured for an ULIP?

COSTS OF OWNING A ULIP:

1) Premium Allocation Charge

The cost structure of ULIPs is such that it starts working to your benefit only after 5-8 years of investing. A part of your premium payment goes into Premium Allocation Charge, which is calculated as a percentage of the premium. This percentage is generally higher in the first few years-the main reason: it takes years to break even on investments. It could be as high as 40% of each year's premium.

2) Policy Administration Charge

A monthly fixed amount that usually rises every year with inflation or as a percentage of the sum assured.

3) Mortality/Rider Charges

ULIPs also have mortality/rider charges, which depends on age, sex and the level of risk cover in a particular year. If you don't avail risk cover, mortality charges can be zero. The mortality charge per Rs 1,000 of the sum assured varies from 1.3 for a 30-year-old to 6.4 for a fifty-year-old.

4) Fund Management Charge (FMC)

Then you have the fund management charge, an adjustment to net asset value (NAV) on a daily basis. Usually, insurers charge it as a percentage of funds under management. ULIPs could have a fund management charge between 0.5%-2.0% per annum.

So with so many chargers around what should be the strategy to get good retuns from ULIPs

STAY LONG TO REAP THE BENEFITS:

If you are ready to cool your heels for 10 years, ULIPs will be a viable financial option. If you anticipate some liquidity need in one to three years from now, ULIPs are not for you. You should look at this investment product only if you leave your money untouched for beyond five years. A good time horizon would be around five years to 30 years. ULIPs are meant for disciplined, regular and systematic investment towards a goal.

The reason is that if you invest the same amount in a mutual fund as well as a ULIP, the former gives better returns than the latter because of the cost structure. There is a point of inflexion at six years, then on the ULIPs begin to give better returns than mutual funds.

THUMB RULES FIR ULIPS:

Start Early: If you start at the age of 30-35, you can create a 20-year long-term investment by investing in SIP route.

Invest Regularly: Do not get deterred by market swings. A systematic long-term periodic investment will help you go a long way.

Choose your fund:

Depending upon your age and risk profile. Use the switches effectively.

You may have opted for a mix of 75% equity and 25% debt on your ULIP. But when you inch closer towards maturity, minimize your exposure to equity as low as 20%. If the market turns bearish, it may slash your assets at the time of maturity. It's better to bet safe as you are close to retirement, Also have a rein on the number of switches though they come free of cost. Frequent change in asset allocation might not be a wise move after all.

You should always have a balanced approach to your investments in your middle age. It protects you better from risks. Now, even if you go for a long-term ULIP, it works to your advantage as it isn't adversely affected by the vagaries of the equity market.