I am always confused whether to refer ULIP as Investment product or Insurance product. It cannot be attributed to my financial illiteracy. ULIP is a mix of both investment and insurance i.e. Jack of all trades. Till date ULIP has a roller coaster ride. Once it was darling of both buyer and the seller then it was most hated product which no investor wanted to touch. Thanks to IRDA for clearing most of the mess around ULIP. Acche Din of ULIP are back with dream run of stock market since Sep’13. In my opinion, fate of ULIP is linked to performance of stock market. Like Mangoes & Strawberry, its a seasonal product :). In last 6 months, most of the insurance companies have launched ULIP’s to benefit from Bull Run. In my previous post on ULIP, Beware of Hidden ULIP Charges i highlighted various hidden charges of ULIP. Though ULIP is now very cheap but still is it worth investing in ULIP, Lets check.
Tax benefit u/s 80C on ULIP
Currently the sales pitch around ULIP is tax savings u/s 80C. The limit u/s 80C is increased from 1 lakh to 1.5 lakh in this years budget. Banks, Relationship Manager and Agents are trying hard to capture incremental waller share of Rs 50,000. For people in higher tax bracket, its a golden opportunity to save additional tax. One of the biggest tax planning mistake is that people don’t include their own PF contribution under 80C limit. For example, if i am contributing Rs 5000 per month to my EPF account then for FY Rs 60k will automatically be considered u/s 80C. Now i should be worried about balance 90k not 1.5 lakh as projected by so called Financial Planners / Relationship Managers.
Incremental limit of Rs 50,000 (If available) can be utilized by investing equally in PPF and ELSS through SIP. For people in higher income tax bracket, this incremental limit will be utilized automatically through tuition fees of kids, EPF Contribution etc therefore incremental investment might not be required in all the cases.
ULIP is Cheaper Now
Another sales pitch from sale executive. Being cheap is always relative term. Its a marketing gimmick. For example, Gold was Rs 33,000 per 10 gm and now it is Rs 27,500 per 10 gm therefore it is cheaper. In comparison to 2004 when rate of gold was Rs 5500 per 10 gm, gold rate has increased 5 times. Therefore gold is cheaper compared to peak but historically its price has increased 500% in 10 years therefore not cheap compared to past. Same goes for ULIP, In 2008 ULIP allocation charges were almost 100% of premium for first few years. Now it is approx upto 45% (with high mortality charges) excluding commission applicable in case of offline product. Therefore 45% is cheap compared to 100%. Just to take an example, IRDA has restricted that in 5th year the difference between Gross and Net yield should not be more than 4%. It implies, if in next 5 years both stock market and ULIP deliver annual return of 12% then return from ULIP will be 8% i.e. Gross yield will be 12% and net yield will be 8%. This difference of gross and net yield is capped at 3% in 10th year and 2.25% from 15th year. In short, only after 15 years, the expense ratio will be comparable to expense ratio of mutual funds.
If we buy ULIP offline then there is an agent commission of 15% and 30% of 1st years premium for 5 year and 10 year policy respectively. Besides this 5% commission of annual premium is fixed for rest period i.e. 2nd year onwards.
Future (Stock Market) is always Bright
I can bet that when stock market is in bear phase, ULIP is off the shelf. Bear phase is off season for ULIP. At the end of the day, investment component of ULIP is invested in stock market therefore beware that returns from ULIP are not guaranteed. Secondly, considering the lock in period of 5 years don’t expect annualized return of more than 12% (Annualized return of stock market in long run is only 11% in last 5 years with period of high and low Blood Pressure for investors). Also Remember that you are paying a high cost for these returns which i discussed in my post on Hidden Charges in ULIP. After adjusting the cost, net return from ULIP will not be more than 8.5%, which is return of any good debt option like PPF or debt mutual funds. Indexation benefit in Debt mutual funds after 3 years will reduce tax liability to almost Zero.
Besides this you will be carrying a high risk, assuming market is in bear phase at the time of maturity or after 5 years when lock in period will be over then you will be at financial loss. Therefore it is advisable to understand the market cycle before investing in products similar to ULIP.
ULIP as Long Term Investment
Due to high initial charges, the true potential of ULIP is unlocked if you stay invested for long duration say 12 to 15 years. The initial expenses are apportioned and returns are better. From financial perspective, front loading of all the charges is not good for investor. Investor will stand to loose in case of premature withdrawal after 5 year lock in period.
Lock-in Period
As investment under ULIP is deductible u/s 80C therefore there is a lock-in period of 5 years. The flip side is that if your ULIP scheme is not performing then you cannot exit the same. Its like closed ended mutual fund. In recent past, most of the fund houses launched closed ended mutual funds. The objective of such schemes is to lock-in investment of the customer in anticipation of fall in market. Any reversal of market from bull to bear phase put lot of redemption pressure therefore to lock investment, closed ended mutual funds are launched. From investor perspective, it is not a good strategy as funds are locked during bull phase and in all probability maturity will be during bear phase.
Personal Finance Goal
Last but the least, the goal of ULIP is not clear whether it is an investment plan or insurance product. Traditional insurance plans like Money Bank policy or Endowment Plans, we insure >> invest >> expect returns whereas in ULIP we invest >> expect return >> insure therefore it is no different. Only prime objective is different in both products. Investment and Insurance should never be mixed with each other and both should be kept separate to achieve each of the goals. Any combination of investment and insurance create confusion e.g. if i am paying a premium of Rs 10,000 for ULIP then assuming Rs 2000 is misc charges, Rs 3000 is diverted for insurance coverage and Rs 5000 is invested. As an investor i will be confused as i will not be able to track my returns on investment. At the same time, i will be under insured. It is advisable to keep both investment and insurance goals separately.
Alternative to ULIP
In layman terms, ULIP is combination of mutual fund and insurance plan. You can achieve objective of ULIP by segregating investments in Insurance and Mutual Funds
(a) Insurance: Instead of buying costly insurance cover bundled with ULIP. You may opt for cheapest online term insurance plan. 35 year old healthy male can get a term insurance cover of whopping 1 Cr at just Rs 9,000 per month whereas in ULIP sum assured is normally 10 times the annual premium. For 9,000 premium sum assured will be approx Rs 90,000 only i.e. approx 1% of coverage under term insurance plan. Premium paid towards Term Insurance plan is allowed for tax deduction under section 80C.
(b) Mutual Funds: From tax savings perspective, you may invest in Equity Linked Savings Scheme with lock-in period of 3 years compared to 5 years for ULIP. Purely from investment perspective, you may select best performing mutual funds either in equity or debt depending on requirement. Unlike ULIP, you can review your portfolio periodically and change your fund portfolio based on performance. By churning portfolio you can maximize your returns. The performance of mutual funds can be tracked almost on daily basis through NAV’s. Comparative data of various ULIP’s are not available in public domain. Lastly, mutual fund ratings are published by CRISIL, Value Research Online etc but ULIP ratings are not available for comparison.
To summarize, term insurance and mutual funds are best alternative to ULIP investment which can provide better returns and more insurance coverage with same premium along with income tax benefit. The premium can be divided among these 2 options depending on individual requirement. The amount received under both the schemes i.e. equity mutual fund/ELSS or sum insured under Online Term Insurance are tax free in the hands of recipient. Lock-in of ELSS is 3 years and in case of Equity Mutual Funds, redemption is tax free after 1 year i.e. Long Term Capital Gain is Nil. In Unit Linked Plan, amount is received only at the time of maturity or to nominee in case of unfortunate event of death of insured person.
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