While the stock markets are volatile, bank-led insurers are aggressively selling unit-linked insurance plans (Ulips) of life insurance companies. The introduction of long-terms capital gains on equity and equity-related investments has given an edge to Ulips as they are exempt from tax at the time of maturity. It is an exempt-exempt-exempt product and the investor can claim tax exemption under section 80C of the Income Tax Act, 1961.
The amount invested in Ulips is eligible for tax deduction under Section 80C subject to a maximum of Rs 1.5 lakh a year but with the condition that premium should not exceed 10% of the sum assured. One can invest in Ulips for long-term financial goals such as retirement, higher education of children and their marriage.
Insurance and investments
These products are market-linked investment products with a thin crust of life insurance and the lock-in period is five years. Policyholders have the option of selecting large-, mid- or small-cap or even debt fund to invest depending on their risk appetite. An investor can buy endowment Ulip and can withdraw the fund value after five years. In mutual funds, only equity-linked savings schemes (ELSS) have a three-year lock-in period.
As Ulips are market-linked, they can be volatile in the short-term. Market volatility can affect the fund’s net asset value daily and the returns are not guaranteed by the insurer. Traditional policies are not market-linked and the investment is done in debt-related instruments.
For policyholders, returns depends on the kind of fund option they select. The NAV of the funds are declared every day by the insurers. Ulips allow the policyholder to switch between the fund options on paying switching charges to the insurance company. However, since Ulips are mainly equity-related investments, policyholders must look at a long-period of holding, ideally 10 years, to reap the gains from the markets and link it to long-term financial goals.
Policyholders should look at cost structure carefully before investing in Ulips as higher costs will reduce the value of the fund in the long-run. In equity-related investments, the expense ratio of mutual funds is one of the lowest at 1.5-3%.
In 2010, the insurance regulator capped the exorbitant charges levied by the insurers, which were front-loaded. It has capped the charges and net reduction in yield for the customers. Currently, there are four kinds of charges in Ulip allocation, policy administration, mortality and fund management charges. The fund management charges are capped at 1.35%. The policyholder should assess his own risk profile before investing in Ulips and the risk-reward ratio for Ulips is high.
The premium allocation charge in Ulips is directly deducted from the premium paid by the policyholder for allocating the units. It is charged by the insurers to recover the costs incurred in processing the policy such as underwriting, medical examinations and distributor fees. Mortality charges compensate the company in case the policyholder does not live till the policy period and if the insurer has to pay any death benefit.
The mortality charge will depend on the age of the policyholder, occupation, location and is calculated per thousand of sum at risk. So, higher the sum at risk, higher will be the charge. Also, greater the age, greater would be mortality charges on the Ulips. Mortality rate is higher for Ulips as compared with term plans.
The fund management charge is deducted towards managing the fund and is levied as a percentage of the value of assets. It is deducted by the insurer before arriving at the net asset value. As it is levied on the accumulated amount and as per regulatory norms, insurers cannot levy fund management charges more than 1.5%.
Ideally, an individual should opt for a pure term insurance plan to cover the life risk and protect the family. For investments, he should look at equity mutual funds for higher long-term returns. Moreover, a mutual fund investor can pause his systematic investment plans in case of a financial crunch or stop the investment if the fund is under performing. However, in Ulips the individual will have to stay invested for five years. So, look at all the aspects before deciding on investing in Ulips.