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The current hottest sold life insurance products are Unit Linked Life Insurance plans. But investors are divided on their opinions about the plans. This article is the first in the series that discuss ULIPs in detail.
How ULIPs work?
ULIPs are insurance plans which are designed around the portfolio management principles used in mutual funds. The premium that is paid is divided as under:
The administration charges are the charges that the company takes out for the premium towards payment to the sales people (Insurance agent or bank that sold the policy to you. Banks in fact get a higher commission than the individual agent), and other office expenses. Some companies may disguise these charges using different names. An investor has to be careful here in reading the chart showing the total charges. These are generally shown as % of the premium and as Rs charged per month. These charges are generally higher during the first few years and can come down to zero latter.
IRDA has recently put in a cap on the average charges that could be charged during the tenure of the ULIP life insurance plans. This has reduced the charges to bearable levels across the companies. Earlier some companies were charging 100 per cent of the first years' premium, when some were charging as low as 5 per cent of the first year's premium for regular premium plans.
Mortality charges are charged towards the actual life insurance cover. These are generally shown as Rs per thousand sum assured. The mortality charge varies (increases) with the age of the insured person. The charges for this are generally low as shown in the table below:
|
Age |
Charge Rs per thousand of life cover |
Charge Rs per lakh of life cover |
|
20 |
1.33 |
130 |
|
30 |
1.46 |
146 |
|
40 |
2.48 |
248 |
|
50 |
5.91 |
591 |
|
60 |
14.21 |
1421 |
The above table may differ for different companies; but not by much.
The minimum cover in any ULIP has to be atleast 5 times the premium. This is to ensure tax benefit under Section 10(10)D of the Income Tax Act. Beware of sales people who give cover equal to the premium or nil life cover. Some do this to con you by saying that these plans can be given without any medical test.
But the question is why a life insurance plan without life insurance? One could as well invest in something else.
Investment Component: The rest of the premium after deducting the administrative charges and the mortality charges gets invested for us. The investment pattern is similar to that of mutual funds. We have our own account and 'units' are allotted based on the investment amount at current net asset values.
The advantage of ULIPs over mutual funds is that for the same policy we get the choice of many funds. The funds are generally based on 4 types:
Many companies offer other variations of the above to their clients. There are some thematic funds too.
Other Charges in ULIPs
There are a number of other charges that may accompany a ULIP. Some of them are listed below:
Surrender charges
This charge is levied in case a policy holder surrenders the policy before the planned maturity date. Some companies do not charge anything after the fifth year. There are others that charge till the tenth year. This charge is generally done as a percentage of the first year's premium or as a percentage of the fund itself.
Withdrawal charges
ULIPs generally allow withdrawal from our funds after the stipulated 3 years. However there may be charges if there is request for more than one withdrawal in a year. Some plans may restrict the amount of withdrawal to a percentage of the available fund (say 20 per cent of the fund value).
Switching charges
Switching is the shifting of our investment from one fund to another. This is done to preserve our profits or to protect our principle. During market highs or the beginning of a downturn a switch from equity oriented funds to debt oriented funds will protect the policy holder's profits. The funds can be switched back after the market falls or is in the recovery phase.
Similarly towards the maturity of the plan a gradual shifting of the funds can be done towards the debt funds to preserve capital.
Switching is a market timing activity and has to be done with knowledge and skills. It is advisable for a normal investor to seek the support of experts in using the switch option.
ULIPs generally offer a number of switches ranging from 4 to 12 for free in a year. Any switches above this will be charged.
Policy administration charges
This charge should ideally be included in the administrative charges discussed earlier. However some companies charge an additional fixed fee per month (irrespective of the premium) as policy administrative charge. This is generally in the range of Rs 25 to 75 per month.
Rider charges
Riders are add-on policies that give additional insurance benefits apart from the base plan. The charges are generally low compared to the benefits added. Some of the popular riders are related to accident cover, disability cover, waiver of premium, and critical illness cover.
Most children plans will also have a rider for the regular income to the family in case the policy holder passes away during the term of the plan. This rider is a market innovation that is very beneficial to the protected family.