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Before you invest

If you are window-shopping for a Ulip, here are some of the essentials you should consider.

  • August 26, 2010  
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Despite several changes in Ulips in the recent past, their core has not changed. They remain long-term investment-cum-insurance plans and are as prone to mis-selling as ever. It is therefore important that investors understand how Ulips can work for them as an investment product. We asked experts on the type of investors who should go in for Ulips, things to keep in mind and ways to choose the right policy.

WHY YOU SHOULD BUY A ULIP BEFORE MARCH 31

Tax-free income is one of the biggest draws of life insurance. But the Direct Taxes Code (DTC) proposes to change the rules. An insurance policy must offer a life cover of at least 20 times the annual premium for the income to be tax-free. So, a Ulip with an annual premium of Rs 50,000 must have a cover of Rs 10 lakh to qualify for tax exemption. The original DTC draft released last year was ambiguous on whether this rule would apply retrospectively or after the code comes into effect from April 1, 2011.

The policyholders whose plans were set to mature went into a tizzy and financial planners were advising clients to not buy long-term products. Now, the revised DTC draft has clarified that existing investments will not be affected, which means that your investments in Ulips and your withdrawals during maturity or earlier are completely tax-free for existing policies.

This makes Ulips a great investment right now. "We believe Ulips will emerge as the best instrument for financial protection, covering a wide gamut of financial needs, including wealth generation," says V. Srinivasan, CFO, Bharti AXA Life Insurance.

Buying a Ulip becomes even more compelling if you take into account that gains from equities will no longer be tax-free after DTC comes into effect. But if one buys a longterm plan for 20-25 years before March 31, he can continue earning tax-free income from stocks till the plan matures.

Who Should Invest

The foremost requirement of Ulips is that the buyer should be willing to invest in equities. If he opts for a debt or liquid fund, the Ulip will lose its edge over a traditional policy. "Debt and liquid funds offer very low returns. Given the high charges of Ulips, the buyer can get the same returns from a traditional money-back plan," says Karthikeyan Jawahar, a Coimbatore-based certified financial planner. You also need to be proactive.

Financial planning consultant Manish Chauhan points out that an "invest and forget" approach won't yield high returns. "The biggest advantage of a Ulip is the switching facility. If an investor is adept at switching between equity and debt, he can gain from market movements and protect his wealth from the downsides," he says. If the buyer doesn't know the basics of the capital market, he should steer clear of Ulips.

Which Plan is the Best
Ulips are insurance plans that cover the risk of death. However, the insurance cover comes with riders. Some Ulips (also called Type I plans) give only the sum that is the higher of the two - fund value or sum assured. These plans stop deducting mortality charges after the fund value crosses the sum assured, rendering the insurance cover meaningless. What good is a Rs 2-lakh cover when the fund value is Rs 2.5 lakh and the nominee gets only the higher amount?

Chauhan advises that investors should choose the Ulips that give both the fund value and sum assured on death. These are the Type II Ulips, which deduct mortality charges throughout the term, but also ensure that the insurance objective of the Ulip remains intact. The other thing to keep in mind is that the simpler the plan, the better it is. A Ulip is a complicated product and if more complexities are built into it, it leads to greater confusion.

Says Suresh Sadagopan, certified financial planner and Director of Ladder7 Financial Advisories: "There are Ulips that even financial planners find difficult to understand. So, how can the average investor know if it will work for him?" Instead, choose a simple Ulip that invests your money in the market as per the asset allocation chosen by you.

 THE COST FACTOR

Most financial planners and consultants insist that Ulips are costlier than mutual funds, considering the commissions paid to agents. However, this is only true for short-term investments. In the long term, Ulips are cheaper for investors as the commission paid reduces drastically. Ulip commissions can be as high as 20-40 per cent of the premium paid in the first year, but this reduces to two per cent from the second year. The commission is a fixed percentage of the premium paid. So, if an investor pays a premium of Rs 1 lakh per year, the commission in the first year is between Rs 20,000 and Rs 40,000, but only Rs 2,000 thereafter.

Mutual fund costs, including commissions, are generally unknown to investors. Trail commission - what a distributor earns directly from the asset management company (AMC) - is a fixed percentage of your cumulative investment in the fund. It can range from 0.1-1 per cent. Most AMCs pay a competitive 0.4 per cent. For example, if your investment in a fund is Rs 10 lakh and the AMC pays 0.5 per cent trail commission, your agent earns Rs 5,000. As your investment value grows every year, so does the agent's commission. In the long term, fund commissions exceed the Ulip charges.

So, why do agents mis-sell? The cost of the products is such that agents get paid a higher commission on mutual funds in the long term, while Ulips are attractive for the short term (five years). Though the total costs are capped, those on yearly basis are not, and this allows for high charges in the initial years for Ulips.

There are also chances that the agent will encourage the investor to surrender the policy or let it lapse after a few years to sell him/her more financial products. Even though IRDA had introduced initiatives to deter mis-selling - limiting the difference between gross and net yield to 2.25-3 per cent for different tenures and increasing the lock-in period for Ulips to five years - the practice continues to be prevalent.

Which Features to Choose

Ulips are front-loaded because insurers have to recover their marketing and sales expenses. Yet, these charges differ across insurers and plans. Choose a plan that does not levy too high a charge in the initial years. Also, invest in a Ulip for at least 10 years. Given the high charges in the initial years, a Ulip will start making money for the investor only after the seventh or eighth year. "Don't go for plans of less than 10 years if you want to reap the benefits of a Ulip," says Deepak Yohannan, CEO and cofounder of iGear Financial Services.

Experts also advise opting for the highest possible risk cover offered by a plan. While it is tempting to go for the minimum cover because mortality charges are low, pick a risk cover of 20 times the annual premium. It's a good idea to choose a plan that gives you the flexibility to increase or decrease the risk cover anytime during the term of the plan.

Courtesy: Money Today