ULIP #1 – understand the product

Of late I have seen a lot of articles and posts in the social media denouncing ULIP as a product and actively discouraging all readers to have anything to do with it. I am no supporter of ULIP, as I had a bad experience with it myself many years back, but it really seems odd to me that people pronounce judgement without having knowledge of the basic features of the product or knowing how it works. The objective of this post is not to encourage readers to go ahead and invest in ULIP but to give them sufficient accurate knowledge so that they are able to judge for themselves.

So let us start from the beginning. As we all know ULIP is a combination of insurance and investment which are clearly two different product classes. Why was such a product formed in the first place? Well, some smart person thought that if insurance, which many people view as a necessary evil, could be spruced up with an investment attraction there may be many takers. The idea was to give good returns to the investors while providing a certain amount of investment cover. Initially it worked quite well but the problems were with the way charges were defined for the product. We will cover this in a later post but the indiscriminate wrong selling of this product has earned it a bad name and deservedly so. But the basic idea of two product classes being blended is not a bad idea as such. Think of it and you will see several types of MF categories which do exactly that. Be it Balanced funds, MIP, some types of FMP the logic is basically the same.

How does the product work? Like any insurance product, there are certain charges that are used up to provide the insurance cover. The remaining part is used for investment, much like what any fund manager in a MF scheme. The underlying asset class that both MF and ULIP invest in is equity, so there is really no scope of differentiation in returns. As insurance is normally a long term product, ULIP was also designed to be a long term product initially. This was done by restricting any withdrawal prior to 3 years but, more importantly, by ensuring that due to the high upfront charges the investor had to stay invested for a longer term if he wanted to get good returns. While the policy was good in intent, the implementation by the distributors was quite terrible. A huge amount of the first year premium was diverted towards the charges that went to the distributors.

Once IRDA as the regulator got into the act, most of the players were forced to clean up their act. The charges were rationalised, the withdrawals were made simpler and in general there was much greater transparency. In addition to this ULIPs had to compete with the ever growing popularity of MF. This meant that the focus on performance and returns was much more important than before.

All this has meant ULIP is a far better product today than many give it credit for. In order to understand the why part of it you need to be clear about the charges and how they have changed. I will cover it in the next post.



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