ULIP #3 -How to use it for goals

I had started writing a series on ULIP but it had got interrupted as I thought some other posts will be more relevant. Readers who are interested in the previous posts can read them to get an idea of why the older ULIP’s were a bad idea and how the different charges connected with them work.

As ULIP is an unique product it can be used in a very innovative way, by taking advantage of insurance and market linked growth combination. Let me give you an example below in order to demonstrate how it can be used:-

  • Suppose you are planning for your child’s education in college which is 15 years away. Normally you will do some SIP in MF to achieve this goal.
  • The risk in above is something unfortunate happening to you, in which case the SIP may stop. This can be taken care of through insurances that you will have. However, as the insurance is not linked to the specific goal, someone will still need to manage the process of continuing the investment on your behalf.
  • An alternative can be to use ULIP. If your goal is 20 lacs in current money terms, take a policy with an equivalent life cover. Keep paying the regular premium.
  • If at all, something untoward happens the amount received can be simply put in a debt fund so that it grows to a reasonable level by the time the goal comes.
  • If you go for an online ULIP then the policy allocation charges are quite low. This will ensure that the overall cost structure of the ULIP is low.
  • Note that ULIP and MF both invest in the same underlying asset class. As such there is really no reason why an ULIP will under perform an MF. The real problem is with the charges and that has got addressed to a large degree now.

I am not saying that you should or should not look at ULIP as an investment product. However, in the changed form it does offer you a lot of flexibility and benefits. In order to convince yourself, look at the performance of some of the recent ULIP for yourself, both in terms of the returns as well as the charges.

You may then well start wondering as to why you have not thought of it earlier !!

ULIP #2 – understand the charges

What are the relevant charges that need to be understood when you are looking at ULIP as an investment option? Well, there are essentially 5 charges which you need to be cognisant about. Let us take a look at the charges and what they mean.

  1. Premium allocation charges : This charge is linked to distribution expenses and underwriting costs for the insurance. In the older ULIP these charges were very significant for two reasons. Firstly, these charges were quite high and secondly, the bulk of these charges were front loaded, to be deducted in the first year. So much so, that nearly 65 % of the first year premium. No wonder ULIP was hated by most investors when they found this out, especially since many of them were not clearly told this by agents who sold it to them.
  2. Policy administration charges: These are mainly for the documentation and other administrative charges linked with the insurance part of the ULIP.
  3. Mortality charges : These are also linked to the insurance of the investor.
  4. Fund management charges: This is similar to the Expense Ratio of Mutual Funds and deals with expenses related to investment related expenses.
  5. Surrender charges : Relevant only when you want to discontinue the ULIP.

The first of these charges are linked to how the ULIP is sold. In case you are buying it from an agent like a bank, expect it to be high, even though after IRDA has got into the act it has become way more reasonable compared to before. However, for many ULIP that you can buy online nowadays these charges are non existent. The other change is that even where the charges are there, front loading like in the past is not really there. This means, much of your money now actually goes into buying the units which is a sea change from the past.

The next 3 charges are in the form of cancelled units and is normally done monthly. IRDA has put caps on the charges and the Fund management charges can today be a maximum of 1.35%, a cost that is significantly lower than the Expense ratio of most MF. Now, IRDA has also stipulated as to how much your overall returns can come down due to all these charges. For example a 15 year ULIP, the overall reduction can be a maximum of 2.25% and this is 3% in case of a 10 year ULIP.

What do these changes realistically mean for you as an investor? Well, it opens up another investment possibility apart from the regular avenues you are already using. In the next post I will outline how you may be able to use ULIP effectively.

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.