I am often approached by investors who have bought Ulips but have no idea of how their investment is performing. "The agent claims that my Ulip has earned awesome returns in the past few years, but in reality I have not made any gains," they say. They are confused because their account statement shows that the fund value is less than the premium they have paid over the years. So why does the insurance agent claim that the fund has generated high returns, they ask me.
The answer is simple: Ulips are marketed on the returns generated via the growth of the fund's NAV. However, this does not mean your investment will grow at the same rate. Let's understand this with an example. Suppose the NAV rises from Rs 10 to Rs 20 in five years, an appreciation of 100 per cent. Ordinarily, this means your investment of Rs 10,000 should grow to Rs 20,000. However, this is not the case. When you invest Rs 10,000, only Rs 5,000-6,000 is actually invested. The balance accounts for the various charges levied by the insurance company.
The markets are going up during this period, and because you are investing every month or every year, you are also buying at higher NAVs. Thus, at the end of five years, the value of the net investment of about Rs 5,000 will grow to about Rs 10,000, a rise of 100 per cent.
This is only if you opt to remain invested in the growth option of the Ulip, which allocates 80-100 per cent of its corpus to equities. However, if you invest in a balanced (65 per cent equities, 35 per cent debt) or conservative (30 per cent equities, 70 per cent debt) option, it can take 7-10 years or more to break even. A 100 per cent debt or liquid fund option can take close to 12-15 years.
However, when you invest in a mutual fund, fixed deposit or bond, there is no difference between the growth registered by the investment and your returns. The gross yield (what the investment earns if no charges are levied) and the net yield (what it actually earns after taking the charges into account) are absolutely in sync, unlike in Ulips.
This is the sad truth about the Ulip equation. Your investment is reduced by the charges so that the net returns are lower than the amount your investment would have otherwise earned. Investors are told to keep investing patiently. After several years of pouring money into the plan, things are expected to improve and the investor makes some gains.
Why charges are important
Though charges eat into the returns of the investor, they are important for the insurance company and the distributor. They help insurers recover their marketing and other expenses, including the payment of commission to the agent. I am going to risk making a prophecy. If commissions are taken out of the Ulip equation, no adviser will sell or recommend these plans. If there is no entry load on Ulips, you won't have telemarketers calling you up or insurance agents running after you to sell a plan.
I am not anti-Ulip. I believe it is an interesting concept and can be profitable for all concerned. The problem is the way Ulips are designed and offered. If the Insurance Regulatory and Development Authority (Irda) or the Securities and Exchange Board of India (Sebi), or both, can fix this product, Ulip can become a vital financial planning tool. However, the recent amendments are arbitrary, miscellaneous and not in the interest of the consumers at large. In their current form, Ulips are not worth your hard-earned money.
What Irda should do
When it abolished entry loads for mutual funds, Sebi effectively removed the bias in the way mutual funds are sold. The customer and the adviser mutually decide on the compensation payable for the services rendered. This is a very progressive measure, which the insurance industry should emulate. All charges other than mortality costs and fund management expenses should be eliminated. This should be the first priority for the insurance regulator.
The mortality premium rate tends to increase with age. As a result, this component keeps rising and eating into the returns. Why should this be so? If a company is willing to sell a term plan with a level premium to the same customer, why is he charged a higher premium for a Ulip?
Then again, why should the sum assured be linked to the premium payment capacity of the policyholder? Why the multiple of five times the annual premium? This was not the case when Ulips were launched in 2001. There was far greater flexibility when it came to choosing the insurance cover. One could take a plan with an annual premium of Rs 20,000 with a life insurance cover of Rs 20 lakh as long as the policy was sustainable by underwriters.
Sadly, this part of the recent history has been conveniently forgotten. Somewhere along the line the hunger for higher premium ticket size and higher commission escalated. Why didn't Irda act then? Was that wrong or is the raw deal that investors get today right in the eyes of the regulator?
There was flexibility in terms of increasing and decreasing the sum assured based on life's circumstances. I am not sure if this feature exists any longer. It did not matter to the insurance company as it would simply cancel the units to the extent of the gap between the sum assured and the fund value in order to deduct the mortality premium. The investment risk was anyway in the hands of the consumer. This beautiful aspect of Ulip has been relegated to the back burner today.
In some cases, partial withdrawals from a Ulip lead to a reduction in the life cover. If the policy is feasible even after the withdrawal, why should this benefit result in a penalty in the form of a curtailed risk cover?
Ulips have become more complex over the years, but have lost value in terms of the benefits offered to investors. Irda should act as a beacon to facilitate better designs for Ulips.
Flexibility of a perfect Ulip
The writer is a certified financial planner and can be contacted at kartik.jhaveri@transcend-india.com
