During the previous financial year (2006-07), most investors would have interacted with their investment advisors and agents for tax-planning. And there's a fair chance that unit linked insurance plans featured prominently in the advisor's recommendation. In recent times, few investment avenues (especially in the tax-saving space) can claim to match ULIPs in terms of their sheer popularity.
ULIPs essentially combine the benefits of an insurance policy and a market-linked investment. A certain proportion of the premium paid is invested in market-linked instruments like equities and bonds (in line with the stated mandate) and the balance is used to provide for the expenses incurred on providing the investor with an insurance cover. Like most other products in the tax-saving segment, ULIPs are also designed to achieve the twin objectives of tax benefits and capital appreciation.
With this elementary understanding of ULIPs, we shall now try and explore what is it about ULIPs that makes them so popular with investment advisors and investors alike.
The attractive agency commission
An advisor selling a ULIP is likely to pocket a commission in the range of 30.00 per cent of the premium paid in the first few years. Conversely, an investment in a tax-saving mutual fund (which offers the same tax benefits under Section 80C of the Income Tax Act) would fetch him an upfront commission of 2.00-2.50 per cent of the investment value.
Also the commission in the following years (known as trail commission) amounts to about 5.00 per cent for ULIP investments vis-a-vis around 0.70 per cent in case of mutual funds. The attractive commissions on ULIPs compared to other avenues like mutual funds and term plans certainly works as a major incentive for the advisor. It is not difficult to understand why an advisor would hard sell ULIPs to every prospective insurance seeker regardless of whether ULIPs are suited to meet the latter's needs.
In India, insurance is sold, not bought
Traditionally, insurance has been bought for tax-saving, rather than from the perspective of insuring oneself. Hence, the 'insurance' aspect typically takes a backseat. Furthermore, awareness among investors in terms of insurance products tends to be low. Most rely solely on their insurance agent for recommendations. We have already discussed why an insurance agent is likely to recommend a ULIP on priority.
For most individuals, a term plan should be the first product to feature in their insurance portfolios; investment-linked products like endowment and ULIPs can be bought as and when the need arises.
Term plans provide the insured's nominees with the sum assured if an eventuality occurs during the term of the policy. There are no maturity benefits; hence if the insured were to survive the policy term, he would not get anything. Sadly, buying term plans is never considered because of the mindset - "I have paid money (premium) towards the insurance policy, so I should get a return".
Advisors under the pretext of allaying investors' apprehensions of not getting any returns on maturity offer products like ULIPs. Such products with their promise of providing returns, easily catch the fancy of most investors.
The stock market performance in the recent past
The sustained bull run in the equity markets over the past few years has resulted in most market-linked investments witnessing considerable growth. This has worked in favour of ULIPs as well. But one must take note of the fact that nearly all the ULIPs in the market are of recent origin and they have not yet been tested over a prolonged bear phase.
Retail investors tend to get carried away by recent performances without realising that there is no guarantee that a similar performance will be sustained in the future. The advisor on his part tends to underplay the recent origin of ULIPs and instead utilises their performance as a selling proposition.
Flexibility offered by ULIPs
ULIPs aren't popular just for the wrong reasons. Rest assured, they have their positives as well. ULIPs offer the kind of flexibility that no insurance product can. For example, investors can select a ULIP with an equity-debt combination that is in line with their risk profile. A risk-taking investor would typically select one with a high equity component, while a risk-averse investor would opt for a debt-heavy one.
Also ULIP investors have the opportunity to 'manage' their monies. When equity markets seem overheated, investors can shift their corpus into a debt-oriented portfolio, and in the process insulate it from volatility in the equity markets. Similar changes can be incorporated when the investor's risk profile undergoes a change.
Then there are advantages like the top-up facility (which is like a one-time premium payment) that can be used to gainfully utilise surplus monies. Another reason for buying a ULIP is the benefit it offers, by bundling insurance with an investment product. Thus for anyone who wants to avoid the hassle of taking care of numerous kinds of investment and life insurance products, ULIPs can be a good option.
Although ULIPs may have become popular for more 'wrong' reasons than 'right' ones, the segment does have its fair share of positives. Investors on their part need to ensure that they invest in a ULIP for the right reasons, after becoming fully aware of the consequences of the investment.
In other words, they need to block all the noise (read biased recommendations from the advisor) and make an informed investment decision based on their risk profile and investment objectives.
Buy Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue - How ULIPs fit in - please click here.
