Editorial Note: Of late, ULIP has  come under severe attack from various quarters due to different reasons. Media has largely carried ULIP bashing reports and not given much space to the pro-ULIP views.

Here is an article that defends ULIP as a viable investment alternative.  We welcome comments on this article at feedback@personalfinancewindow.com

In defense of Unit Linked Insurance Plans

When the Unit Linked Insurance Plan (ULIP) were introduced by the insurance companies, they became hugely popular. So much so that the Mutual Fund (MF) industry started to feel the heat. This has resulted in a ULIP bashing in the media. Almost every article written on the subject says that investments and insurance should not be mixed and one should buy term insurance and stick to MFs for investments.

Surprisingly, nobody from the insurance industry has risen in defense of the ULIP.
To an extent the criticism is justified and the blame must fall primarily on the insurance agent. Most agents project the scheme as a 3-year payment scheme with the option to discontinue payment but supposedly enjoy the benefits of MF investing and also get the insurance cover. People are averse to long-term commitments, hence they are attracted by the option.

This is what most critics pounce on, as what is supposed to be the USP of the scheme is actually its weakness. Insurance Companies write off the policy expenses in the first 2-3 years of the policy duration. So, a very small portion of the premium is invested in these years.  If the policy is redeemed or payments discontinued, the returns would be poor because the amount available for investment is drastically reduced to start with.

A unit linked plan, as are all insurance plans, is a long-term solution and should not be looked at as having the flexibility of short-term withdrawal.

(I)  Insurance as a Hedge 

When a young individual starts saving, his main objectives are to plan for his retirement, and also along the way plan for his children’s education or marriage etc. So, he is constantly saving and investing to achieve a sum, which he feels would be sufficient to achieve his goal. Life Insurance cover provides the certainty of achievement of the goals even in the unfortunate eventuality of death of an  individual.

As the investments value increases, the requirement of Life Insurance gets reduced. This benefits the individual because as age increases, the cost of life insurance also increases.

A Unit Linked Endowment Plan works exactly the same way. There is a target amount, which is the sum of investment value and the insurance cover. Initially, it is the whole of insurance cover. As the premiums are paid and the investment value increases, the insurance cover gets reduced to that extent so that with increasing age and investment value the insurance cost gets reduced.

Let me illustrate this with an example. Suppose your target amount is Rs 50 Lakhs. So you buy a ULEP with Rs 2 lakh annual premium for 25 years and the Sum Assured is for Rs 50 Lakhs. Initially the insurance is for Rs 50 lakhs and the cost is recovered accordingly. After 5 years of premium payment, which is Rs 10 lakhs and due to appreciation lets say, the portfolio value has become Rs 12 lakhs, the insurance cover will be for Rs 50 lakhs minus Rs 12 lakhs. i.e. Rs 38 lakhs. This way as the portfolio value increases the amount of insurance cover and hence the cost reduces. 

(II)  Insurance Funds can take better advantage of opportunities

It has been observed that the MF investors, especially the equity fund investors, also try to time the market even with their fund investments. Naturally, many times it results in investors withdrawing funds in panic when there is a sudden dip and the rumours are flying. For fund managers, this is possibly the best time to invest but in reality they have to sell rather than buy due to investor redemption pressures. The converse is also true when the markets are euphoric and the investors are pumping in money. 

The insurance funds are well poised to take advantage of these situations as there are never any redemption pressures and they are flush with cash. They can pick and choose their time for purchases or sales. 

Of course, this is true of mainly equity funds. Policyholders or their advisors are supposed to choose the fund they want to invest in a unit-linked plan. If they choose a pure debt fund, they may not enjoy this advantage.

(III)  Costs

It is ironical that I am mentioning cost as an advantage when that is the biggest criticism these type of plans face.

This is because when most critics of ULIP  talk of costs of ULIP  plan vis-à-vis Mutual Funds, the focus is on the upfront cost discussed earlier.

Nobody pays attention to the annual fees charged by the fund houses, which is actually the biggest cost of investment. This fee is charged to the investment value, which is continuously growing due to additional investments as well as appreciation of the fund value.

MFs typically charge 2% plus annual fees. There are quite a few insurance companies who charge 1.5% or less annual fees. In fact, one leading insurance company charges only 0.8% annual fees on all its funds including its equity fund.

A comparison of investment in MF and a ULIP  (charging say 1% annual fees) assuming a Rs 10,000 per month investment over a 20-year period - will give an idea of how much this difference is over a longer period of time.

 
The charges given are for that year only. If one calculates the cumulative difference, it would be huge. 

To conclude, for long-term goal planning, which includes insurance planning, ULIP  are a better alternative and possibly the best option. This is not to say that MF are second best. In fact, for any investment duration of less than 10 years, MFs could be a better alternative. Besides they provide a much more varied choice, be it in the equity space or debt.

So, both options have a place under the sun and they are not mutually exclusive.

The author is a Certified Financial Planner and Director  of VSK Financial Consultancy Services. The views expressed here are his own. He can be reachable at ymsabnis@vskindia.com.