Should I invest in ULIPs?
UNIT Linked Insurance Plans (ULIPs) are policies that club insurance with investment.
Besides getting your basic insurance cover, ULIPs offer between four and six options when it comes to choosing the investment mix.
These range from funds, which invest in 100 per cent equity to those that invest in 100 per cent debt securities.
Wealth offers pointers on ULIPs to help you make a well-informed decision before investing in this product.
ULIPs have something called the ‘premium allocation charge’. This means, the company charges a percentage of the premium towards the premium received. For instance, if you are paying a premium of Rs 45,000 per annum, you are charged a premium allocation charge of approximately 15 to 71 per cent on this amount. The net premium, after deducting this charge, gets invested.
This charge, usually, depends on the ULIP chosen. And remember: your per annum return is calculated on the money invested and not on the premium paid.
A significant proportion of this charge is passed onto an insurance agent as commission. From the third year onwards, most ULIPs have a premium allocation charge anywhere from two to five per cent.
Choosing the best ULIP
When it comes to mutual funds, you can find the best performing schemes through research.
But this is not possible with ULIPs because each plan will differ in terms of the expenses you need to pay upfront. This means that you have to go with what an agent tells you.
Unlike mutual funds or other investment instruments, generally an insurance agent cannot sell products from different insurance companies. He has to sell only those products that are issued by the insurance company he represents. In this scenario, unbiased advice is rare.
Compare ‘n’ contrast before you invest
Though most insurance sellers tend to make tall claims about the return-generating potential of the product, the Insurance Regulatory and Development Authority (IRDA) has specified that a rate of 6 per cent per annum and a rate of 10 per cent per annum, are the only two rates that can be used to forecast the return potential. So, before committing to any particular ULIP, check what else is on the menu.
What products are being offered by competing insurance companies? Keep it conservative by directing the advisor concerned to use a return of 6 per cent per annum over the entire tenure of the policy, to ascertain the maturity value of the policy. This way, all expenses will have to be necessarily factored in.
At the end of the exercise, you will have a much better picture in terms of the strengths and weaknesses of competing offers.
ULIPs are not a bad investment, per se. But they are products, which help you break even after six to eight years. So, think long-term.
If used as short-term investments, your financial health will suffer.
Thumb rule: Get all the information before you invest
So, for those of you who find conflicting advice as painful then this piece should help reduce one area where it rears it’s ugly head — Unit Linked Insurance Plans (ULIPS).
- ULIPs are very expensive and hence must be a kept away from.
- ULIPs are a convenient modern day investment option.
- The returns on ULIPs are on the investible amount, not what you put in, so stay away.
- ULIPs are better than traditional policies.
Which one is true?
here are a few basic facts.
~ A ULIP offers the twin benefits of life insurance as well as an investment. After deducting fees and charges, part of the premium paid goes towards buying insurance cover.
The balance is invested in the funds you choose. You can also track the performance of the fund since returns are linked to market performance. Thus, ULIPs provide protection and flexibility in investment.
~ Traditional policies work along the same lines. Part of the premium is set aside for life cover. The rest is invested in a fund after charges are deducted. The difference is, you don’t know the break-up, performance or the manner in which your returns are paid out.
The returns are in the form of bonuses but you don’t know if the profits from your fund will be paid to you or only a share will. Go for an endowment policy, an option within traditional policies which covers life and offers maturity value at end of term.
“The essential difference in the two plans is, traditional policies encourage savings; ULIPs take the investment path and hence have higher growth options.”
Make the choice
“ULIPs give offer a choice of funds for the risk averse and the aggressive investor, but traditional policies take the investment decisions themselves. Though they many guarantee some returns by way of bonuses.”
ULIP: High charges, low returns!
On friends Advice Prashant invest in a Unit Linked Insurance Plan (ULIP).
The friend told Prashant that the policy would yield ‘good’ market-linked returns and would also take care of his tax investment needs. He only needed to pay a premium for three years.
So, Prashant bought a policy.
Let’s take a closer look at the details.
|Sum assured||Rs 100,000|
|Policy tenure||20 years|
|Yearly premium||Rs 10,000|
|Current value in the fund||Rs 6,115|
Today, Prashant is unhappy with the product because the current value of his fund is Rs 6,115, even though the premium is Rs 10,000.
Where all the money went
ULIP combines insurance and investment; you can choose whether to invest a portion of the premium in debt or the equity market.
What usually fails to come to light: the high charges imposed by insurance companies. This could be anywhere between 2 to 100 per cent!
This amount takes care of the company’s distribution charges, the agents’ commission, etc. But not many investors know about this.
“No doubt, insurance companies do mention the charges in the product brochures. But some agents may conceal information. Or they may not explain it clearly to investors. Even investors do not enquire about it,” . What Prashant pays:
|Policy charge in the first year||26.5 per cent|
|Deducted amount||Rs 2,650|
|Actual amount invested in equity||Rs 7,350|
ULIPs: When its okay to switch
WE are a cautious species. We pray before every important event, we look at auspicious factors when we name our children and we consider broken mirrors a bad sign. It’s no wonder then that when we make a killing in the stock market, we first think about how best to preserve it.
People book profits or switch to a safer option in a bid to play safe. But while that makes sense for those dealing in shares or with mutual funds, does it make sense for those having equity unit linked insurance policies (ULIP)? ULIPs allow you to switch from equity fund option to debt, usually without any fees. But there is a key difference between ULIPs and other stock market investments. ULIPs are a combination of insurance and investment. Since it is your protection cover that you would be tampering with, your decision to switch needs to be well thought out before you exercise it.
“As a ULIP policyholder, you should not look at market timing. ULIPs cannot be compared with mutual funds. Your emphasis should be on long-term investments.”
“Why did you buy ULIPs in the first place, if you wanted to keep switching. ULIPs are a long-term investment product and the market returns are the icing on the cake.
But there are always exceptions to the rule. In some cases a switch might be warranted.
1. Your Long Term goals: Will switching at this point mean deviating from your long term financial planning or will it bring in large benefits.
2. Your Asset allocation: What does your asset allocation say? “You should consider what your financial needs and goals are and what asset allocation will help you to achieve this. Adhere to it and do not falter, despite temptations from the market. For instance, if you have decided to have a 60:40 equity-debt ratio and the markets move, see to it that you still have the 60:40. In such situations, it is advisable to move some funds so as to retain the same ratio. Which means, if you are already invested in equities, may be you could switch to debt, provided it actually falls within your asset allocation.”
3. Your Risk appetite: How much risk can you take? What is your appetite? If you are not market savvy you’d rather switch and book atleast part profits now. Experts like Subramaniam also believe in switching a part, not the whole, “Switch only 60-65%, not the entire fund, to debt. Maybe you could instruct your insurance company to switch your equity component to the balance fund (55% equity) directly since it is a healthy mix of both debt and equity.”
But debt is an option that should be considered by those who have a good knowledge of interest rate fluctuations. Worldwide movement of interest rates have a bearing in India. So if you are a passive investor and want to play safe, simply shift to a cash fund and stay invested.
4. Your Age: If you are young you do not need to really worry about timing the market – your ULIPs will continue to earn. But if you are around 40-45 years or your policy is going to mature in the next few years may be you should consider switching to make the most of what ever you have earned. Your decision to switch should be based on the time left to maturity.
5. Policy period left to maturity: Find out what is the balance period of the policy. Is it just a few years from now or do you still have around 10 years left. In case of the former you could switch but if you still have a decade or so left stick to your fund.
If any of these five reasons apply to you then your switch may be justified. And don’t worry – switches are zero cost. You are allowed two or three switches a year and they dhttp://localhost/theequitymarkets/wp-admin/post.php?post=159&action=edit&message=6on’t even have any tax implications.
So go ahead, put on the switch. And let there be light
Top ups give more
THE problem of too much opportunity today is that nothing is good enough. Complaining about your job or your boss is especially fashionable. This generation is more prone to giving up and starting afresh with another job altogether. Some even switch careers!
It’s no wonder then that their professional behaviour reflects their financial behaviour too.
But why not work further upon what is already doing well for you?
you should be doing is using a top-up facility where the ULIP holder can pay additional premiums as and when he pleases and these premiums can be invested in the existing fund. Why? Because not only are they doing well but he is also familiar with this instrument and it may work out better than buying a new policy or a mutual fund (MF).
Top up v/s New policy
There’s no way to convince you except using hard numbers, so here we go:
a. Suppose you have taken a ULIP by paying a premium of Rs 20,000 per annum for 30 years.
b. After deducting charges (say 20% in the first year and 2% per year thereafter), the balance is invested in a fund of your choice.
c. So out of a premium of Rs 20,000, Rs 4,000 would be deducted in the first year and Rs 400 thereafter leaving you with Rs 5,84,400 as the investible amount of the total 6 lakh.
a. Now, by the same logic if you instead take a policy by paying a premium of Rs 10,000 per annum for 30 years, you would be investing Rs 2,92,200 over 30 years.
b. If you opt for a top-up and pay Rs 10,000 per annum extra you will incur 1% per annum top up charges. So out of the payment of Rs 3 lakh as top-up over 30 years, your actual investment would be Rs 2,97,000.
c. That means your total investment of the base policy and top ups would be Rs 5,89,200 (2,92,200 + 2,97,000).
Thus, you’ve got a bigger investible amount through a top up
Although in this case, the benefit is only Rs 4,800 over 30 years, in case of larger premiums, the benefits would be more substantial.
Since top-ups are attached to the existing ULIP, all the benefits of a ULIP would apply to them such as tax benefits. If your premium plus top-up amount in any year, is less than 20% of your sum assured, then your top-up too qualifies for a tax deduction under section 80C. If however, this ratio of 20% is not maintained, experts suggest that the sum assured can be increased to that extent, so that the top-up qualifies for the tax sop.
But naturally, the top up comes with the same 3 year lock as your ULIP! But that’s hardly a disadvantage ”Top-ups in ULIPs should be made with the objective of creating long-term wealth rather than as a short-term measure to take advantage of the market.”
Top up v/s Mutual fund
Both instruments come with different objectives. “Whether one is looking at a ULIP or MF should depend on their specific financial needs and goals. However, if one is looking for a long-term investment option, a ULIP top-up has several advantages like at ICICI Prudential, a ULIP top-up is charged at only 1%, while the entry load in an MF is usually 2.25%. Further, a top-up can be towards any fund of the ULIP, while in a MF the money will be either towards the existing fund of the customer, or he/she must buy a new MF.”
But that’s not to say that MFs should be ruled out. “MFs offer flexibility in terms of entry and exits, as also in choice of funds. You can invest in thematic funds, mid-caps or multi-caps that can give you good returns.”
Moreover, MFs invest in aggressive sectors like mid-caps or tech stocks while ULIPs have a more conservative approach because of their long-term nature. ”If one is looking only for returns without the insurance, a mutual fund may be a better option.”
So, maybe switching investment avenues or jobs is not such a bad idea. Depending on individual goals, the change might even work better for some. But take stock of your individual situation and options before making a hasty choice. And remember that a new job comes with a new boss who may make your old boss look like an angel in comparison
Careful mistakes you make
MISTAKES can be expensive.
Careful mistakes are the ones we make after long deliberation, wrong calculation leading to the wrong choice. And naturally these cost you more. Lets look at Insurance for instance.
Firstly, we need to be a clear about one point — Insurance is a cost. Whether one would want to incur this cost or not, and to what amount, is a matter of personal choice. And since it is a cost, the obvious thing to do is minimize the cost without sacrificing the basic life cover.
The big mistake
This is where the big mistake comes in: Pure-protection policies, where one doesn’t get anything back if one survives the policy term, are the ideal choice for the above objective. But psychologically, it is difficult for people to pay-up hard cash for an intangible product, ie security. So they go in for insurance products with returns.
Hence, moneyback and endowment (and of late Unit Linked Insurance Plans or ULIPs) type of policies are taken. But this is what they forget:
- The same amount that they would otherwise pay in a term policy also gets deducted from these so-called protection and investment policies. And only the net amount gets invested.
- The administrative costs are high
- Corpus is invested in very safe instruments
- Therefore, the returns from such policies are usually very low — usually in the range of 5-7% pa.
Naturally, a person would be better off taking a term policy to get the life cover and investing the balance premium amount say in PPF where he can earn 8% pa returns (assuming he wants no risk of investing in equity, where the returns can be much higher)
Switched funds in ULIP, lost money
ULIP is a combination of insurance and investment. Of the total premiums paid, some of the money is set aside for the insurance cover and the rest is invested in a fund (of your choice), similar to a mutual fund
Sandeep chose the equity fund option. But soon after, the BSE Sensex crashed in April 2008. The prediction was that it would fall even more.
In a matter of three months Sandeep’s fund value was eroded from Rs 23,000 to Rs 16,224 (a loss of Rs 6,776). He decided to exit the fund.
Since ULIPs have a lock-in period of three years, Sandeep could not sell his fund. But he remembered the ‘switch’ option mentioned by the agent who sold him the policy; he could switch from equity to the debt option or vice-versa. There would be no tax implications and he could do two free switches in a year.
So, on April 8, 2008, Sandeep checked the NAV of his fund in the newspaper; it was Rs 24 (he held 676 units). On the same day, at 1 pm, he decided to exercise the switch.
His fund value before the switch was Rs 16,224. The next day, when he checked his statement, he found that the amount switched was only Rs 15,548 — a difference of Rs 676. He called up the company’s customer care executive and was informed that the switch was exercised at an NAV of Rs 23.
What Sandeep saw in the newspaper was the NAV as on April 7, 2008.
Unlike stock prices, which move during the day, the NAV of insurance companies (and mutual funds) are revised only once a day, after the markets have closed. Sandeep exercised his switch on April 8, 2008 at 1 pm, assuming that the switch would be carried out at an NAV of Rs 24.
Ans:- “According to insurance regulatory guidelines, if the request to switch funds is received before the cut-off time, which is 3 pm, the NAV as on the same day is considered.”
In Sandeep’s case, because he made the switch at 1 pm on April 8, he was allotted the units at an NAV of Rs 23, the NAV declared on that very day.
1: He tried timing the market.
2. He did not read the policy document properly and hence was not aware of switching rules.
ULIP is a product that yields returns in the long-term. So, Sandeep should not have given in to ‘panic-selling’ due to short-term fluctuations.
What he could do now: stay invested.
1. Most companies offer three to four free fund switches in a year. Anything beyond will cost you.
2. A strategy for switching. “When the markets scale up, you can move from equity to debt, and when the markets are low you can switch from debt to equity. You could alternatively look at top-up facility as well.”
The top-up option allows you to invest at irregular intervals. It’s over and above the premium that you pay.
I AM 38 years old. I would like to take a ULIP with a life cover/sum assured of Rs 1 crore. Which policy/scheme/insurance company has the lowest premium for a ULIP with Rs 1 crore as sum assured?
There is no fixed premium for a given sum assured in a ULIP. Mortality charges get deducted according to the sum assured of your choice. You will also have to pay fund management charge, administrative costs etc. These charges can be as steep as 40-65 per cent of your premium payments in the initial year and it will even out to around 5 to 15 per cent after the first year. This remainder amount will be the investible surplus that is utilised for investment in funds.
For instance, say you invest Rs 2 lakh a year in a ULIP for 15 years. At an annual rate of return of 10 per cent, you earn around Rs 54 lakh after 15 years. With zero costs, you would receive Rs 70 lakh. That is, upfront costs were actually to the tune of Rs 16 lakh.
Verdict: ULIPs yield good returns if held for a long-term.
Ask for the benefit illustration
Each insurance company will have a detailed benefit illustration that shows clearly how the costs are allotted and what is the actual amount invested. The benefit illustrations will help you compare the upfront costs of all the short listed insurance plans and help you arrive at the most attractive low cost option. So, before you choose your ULIP policy, understand the costs and charges involved in a ULIP policy.
Here is a preview of the type of costs usually involved.
1. Premium Allocation Charge
This is the initial percentage of funds that are separated for charges before units are allocated according to the guidelines of the policy. This can be as high as 60 per cent in some ULIPS but in some others it could zilch.
2. Mortality Charges
This involves the cost of insurance or life cover that is allocated for the plan. Age, health of the policy holder, and the amount specified for coverage determines this charge. The basis of this charge depends on the type of ULIP. That is, this charge is initially deducted from the entire sum assured. At the final stage, it is charged on the difference between the sum assured and the fund value. In some ULIPS the mortality charge is levied on the sum assured for the whole term.
3. Fund Management Fees
This is charged towards managing your funds and deductible before arriving at the net asset value of your funds. This could be in the range of 1- 1.5 per cent of the assets that are managed.
4. Administration Charges
This can be a flat charge deducted on a monthly basis throughout the plan or may increase over time at a particular percentage.
5. Surrender Charges
A surrender charge is levied when you encash the fund units partially or in full at a premature date.
6. Fund Switching Charge
You are given the choice to switch your funds to different equity or debt options as applicable in your policy. However, the number of times you can make this switch is restricted to a certain number exceeding which you will be levied a charge. This is generally quoted at Rs 100 to 150 per switch after you have exhausted your share of free switches.
7. Service Tax
Service tax is deducted from the funds that are actually used for investment from the premium.
Now, let’s look at an example to understand how exactly are these charges deducted from the premium amount you have paid.
Mahesh invests an annual premium of 70,000 for a sum assured of Rs 7 lakh. He pays a premium allocation charge of 65 per cent in his first year, which works out to Rs 45,000. This will be to the tune of 7.5 per cent to 5 per cent in second and third year.
He also shells out Rs 500 per lakh as administration charge, which works out to Rs 3,500 per year. He pays Rs 1,000 as service tax and a morality charge of Rs 800. That is, the actual funds or the investible surplus works out to Rs 22,200 out of the premium of Rs 70,000.
This figure varies from year to year due to changes in the various charges like the admin charges, the morality charges which increases with age etc.
So when you opt for a ULIP you will need to account for all the expenses in totality before understanding the true value of your investible surplus. Also, as it is clear from above ULIP investments are ill suited for short term investments like a period of 3 years or so, as the policy holder does not stand to reap any suitable benefits for the premium paid
ULIPs for short-term goal?
SACHIN, 23, is a graduate, and working with an international call centre. He earns a handsome salary of Rs 25,000 per month. His father, 45, is self-employed; mother, 42, is a housewife. Sachin has a younger sister, 18, studying in second year junior college. Sachin’s family want to get their daughter married after she completes her graduation – that is another three years away. They did some calculation and decided they will require Rs 2.5 lakh for the marriage.
Sachin works in shifts. So, he hardly has any time to plan his finances, and that is the reason he invest his money into tax saving instruments without realising whether he needs the product or not. Sachin visited his bank to make a Fixed Deposit of Rs 70,000 to save for his sister’s marriage. However, the bank was aggressively promoting bank assurance products. So, when Sachin met the investment advisors of the bank for a fixed deposit, they convinced him to go for Unit Linked Insurance Policies (ULIPs) instead. They told him if he invests Rs 70,000 for next 3 years, he’ll get returns as high as 20 per cent for a year. Sachin went ahead and invested his money, but after the completion of 3 years of the ULIP policy, he received less than his original investment of Rs 210,000.
Analysing the situation
What went wrong? Well, Sachin bought a long-term product (ULIP) for a short-term goal (sister’s marriage). The result was Sachin made a loss on his investment, since he had to withdraw money (surrender the ULIP policy) for his sister’s marriage without giving his investments time to give him favourable return.
Analysis of Sachin’s investment in the ULIP policy.
The surrender value of Sachin’s ULIP investment was Rs 168,688. This amount is insufficient for the marriage of Sachin’s sister.
Constructing an investment portfolio
What Sachin should have done instead of going for ULIPs, was to build a portfolio of debt and equity in the ratio depending on his risk appetite. He could have invested in equity diversified scheme or balanced scheme of mutual funds which could have helped him to generate at least 12 per cent return. While in debt, he could have invested in a bank flexi deposit for next 3 years. This would help Sachin to generate a return of 8 per cent per annum.
Assuming Equity: Debt ratio 60: 40
|Year||Investment Amount (Rs)||Return on Investment||Fund value at the end of 3 years (Rs)|
|Fund Value (Rs)||158,731.78||98,171.14|
|Total Fund Value (Rs)||256,902.91|
If he had done as illustrated above, the maturity value of his investment would have been Rs 256,902. Sachin would have made a profit of Rs 46,902 and also accumulated Rs 2.5 lakh required for his sister’s marriage.
Conclusion: Who can help Sachin?
Ideally, Sachin needs to take care of his own investments. He should read and understand all the information given in the investment document before he signs the contract. In case, he does not have sufficient time to do the same, he should appoint a qualified financial consultant to help him achieve his dream goals.
Cap on ULIP charges: How it affects YOU
AFTER much heartburn over high fees and charges on ULIPs (unit linked insurance plans), there’s finally some good news for investors! The insurance regulatory body, the IRDA, has implemented well defined changes that can make a significant impact for investors looking to invest in ULIPs. According to the norms, there will be a cap on overall charges that the insurance companies can impose upon the ULIPs.
For all ULIPs which have a maturity of up to 10 years, the difference between the gross yield and net yield would have to be maintained at 300 basis points or 3 per cent. Out of this, the investment management fee would not be more than 1.5 per cent. For ULIPs with a tenure longer than 10 years, the overall cap would be 2.25 per cent with an investment management fee cap of 1.25 per cent.
Remember that charges here would include allocation charge, administration charge, mortality charge and all such charges by any other name.
You will notice that the cap on overall charges become lower as the insurance term increases. This move is expected to encourage consumers to opt for long term insurance and investment rather than a short term plan, which is low in utility. This is expected to come into effect by October 1, 2009.
The jargon here are the words ‘gross yield’ and ‘net yield’. So let us simplify them:
Gross yield: This is the yield generated by the ULIP before all charges are deducted
Net yield: This is the yield generated by the ULIP after all charges are deducted
Let us take an example where the annual premium on a ULIP is Rs 20,000 and the term is 10 years. Let us assume that the charges are as follows:
- Allocation charges
First year allocation charge: 25 per cent of premium
Second year allocation charge: 15 per cent of premium
Third year allocation charge: 5 per cent of premium
Fourth year onwards allocation charge: 3 per cent of premium
- Administration charges: Rs 30 per month
– Fund management charge: 1.5 per cent of fund value
Also let us assume that the fund grows at a rate of 10 per cent per annum. For the ease of calculation we have ignored mortality charges.
We need to arrive at two numbers, the gross yield and the net yield.
Gross yield: If the fund grows at 10 per cent every year for 10 years, the fund value at the end of 10 years without taking the impact of charges would be Rs 3.3 lakh. That would translate to an yield of 11.98 per cent.
Net yield: If the fund grows at 10 per cent every year for 10 years, the fund value at the end of 10 years after taking the impact of charges would be Rs 2.7 lakh. That would translate to an yield of 8.07 per cent.
Difference: The difference between gross yield and net yield is 3.91 per cent
Now, post the new norms, this difference cannot be more than 3 per cent. We did a little bit of extrapolation and found that the charges need to be drastically reduced if the yield criteria must be met. The new charges would have to be:
- Allocation charges
First year allocation charge: 15 per cent of premium
Second year allocation charge: 10 per cent of premium
Third year onwards allocation charge: 1 per cent of premium
Administration charges: Rs 26 per month
Fund management charge: 1.5 per cent of fund value
By following these charges, at the end of 10 years, the fund value would be Rs 2.8 lakh instead of the current Rs 2.7 lakh, a saving of Rs 10,000. Of course, this might appear like a small amount, but the difference will increase if the existing charges are far more than what we have assumed above.
Having done this calculation, there are still some doubts. What happens if the ULIP gives only 3 per cent returns over the period of 10 years? The company would have already deducted charges, so how will they compensate the policyholder? Experts say that we would need to wait for clarity on these issues.
Tips for existing investors
- Existing investors who have just started out should try and bide time until an opportune moment like say at the end of 3 or 5 year term and opt out of the policy factoring in how much money they are likely to lose. They can then invest the money in a brand new ULIP policy and benefit.
- Those who are well into their term with a few years left need not worry as the charges will anyways dwindle to around 3 per cent then
Forgot to pay premium
WHAT do fast food, e-mail, instant coffee and 20/20 cricket matches have in common? They bear testimony to the fact that time is money. And both are in short supply!
No time to eat, write a letter, brew good coffee, play a game of 50 overs.
Now, what happened when you had no time to pay insurance premium? A missing a premium is not as simple as missing your cup of coffee; a lapsed policy means wasted money and no cover for your family.
Prakash went abroad on a work assignment for five years. He returned to discover that his policy had lapsed and it could not be revived. He lost the Rs 136,000 (Rs 1.36 lakh), which he had already paid up as premium.
Fortunately for Prakash, nothing untoward happened to him during those five years. But if something did, his dependents would not have got a single Rupee.
Now, the insurance company gave Prakash adequate opportunities to pay up. All insurance companies offer a grace period of about 30 days after the due date. If you don’t pay up within this time frame, your policy will lapse.
If you skip the due date and the grace period, you can still revive your policy. The price you stand to pay: an interest on your premium that can go up to 9 per cent per annum.
This chance of revival can last up to five years with an interest payment, and may even require medical re-examination. If you go abroad, make sure you pay your premium in advance.Now, here’s what the Life Insurance Corporation India officials told us,”If a policy holder wants to revive a policy after five years, we suggest he take up a new policy, since the fine on premium may be very high by that time.”
But even if Prakash’s policy lapsed, why did the insurance company retain Rs 1.36 lakh? Simple. His policy had not acquired the ‘paid-up value’.
“A policy is surrendered or declared paid-up after paying premium for three consecutive years. If your policy has lapsed due to non-payment of premium and has not acquired paid up value, you don’t get any refund.”
When your policy acquires the paid-up value, this means that the sum assured is adjusted according to the premiums you have paid.
Now, in a Unit Linked Insurance Plan, part of the premium is paid towards your life cover, and the rest to your fund account as investment.If you don’t pay your premium, the policy will not lapse. But here’s the catch: the cost of insurance cover is deducted from your fund account. This means that your fund is used to keep your insurance cover alive. If the premium amount already paid up by Prakash, had been enough for the five-year period during his absence, his policy would have, perhaps, continued at the cost of his investment. This may sound like a decent contingency plan. But it’s not!
Investments are meant to grow and earn returns. By using your investment money to pay off your premiums, you are not allowing your investments to grow. So, at the end of the day, there is no getting around the fact that premiums need to be paid. On time!
Should you close your ULIP policy?
UNIT Linked Insurance Plans (ULIPs) have never been a good ‘investment’ product. We have said that over and over again, and there are valid reasons for saying that.
1. The charges are exorbitant and payable upfront in the first 3 years’ of the policy
2. The 3-year lock-in may appear small compared to traditional insurance policies which run up to 15-20 years, but that’s not the right comparison. ULIPs should be compared to MFs, where the open-ended schemes have no lock-in
3. The flexibility is low. You can exit after 3 years, but you may be forced to stay with the ULIP because of paying the hefty charges initially.
4. You are dependent on the performance of just one fund. Instead, you could buy 4-6 MFs with the same money which you pay as premium and build a diversified portfolio and spread your risk.
Why does it sell?
There are many drawbacks but they are still selling, you might say. Insurance companies sell millions of ULIPs because of the following:
1. Belief in safety of insurance products. Unlike traditional policies, ULIPs are investing in the ‘risky’ equity markets.
2. The unexpectedly high returns from equity in last 2 to 3 years enabled ULIPs to show profit despite the high charges.
With the markets crashing, high returns have evaporated. So, now the reality is dawning on policy holders as they are sitting on huge losses. Besides, the loss in the market, the loss of thousands of rupees in the form of heavy charges is the worrying bit.
Should I close the policy?
The cost-structure in ULIPs varies significantly, not only across different insurance companies, but also across different ULIPs from the same insurance company.
So, each policyholder will have to work out the final exit/retain strategy based on his/her specific policy terms. However, there are three factors to be considered:
— Entry Charges or allocation charges
— Annual Costs or fund management charges
The focus, here, is on equity-based ULIPs. And, the basic idea is to check whether it is better to continue paying premiums or instead start investing in MFs.
Case 1: You have paid first 3 years’ premium
Scenario 1: Fund’s performance has been good in the first 3 years and:
1. Both entry and annual fund management charge are lower as compared to MFs
You can continue investing in ULIPs for say 8-10 years till the lower charges in later years offset the high initial charges already paid.
Note: In many ULIPs after 3 years the entry charges (or allocation charge as they are also called) are lower than the 2.25 per cent entry load in MFs (assuming you are investing through a distributor) and the annual charges are also lower than the MFs.
2. Entry charges are higher, but annual charges are lower
You can stop paying further premiums but continue with the policy for say 8-10 years based on premiums already paid. This will help offset the high initial charges.
Now that MFs have no entry load on direct investments, this option may be applicable in most cases.
3. Annual fund management charges are higher
Exit the policy as it may not be prudent to pay high charges on recurrent basis.
Scenario 2: Fund performance has been bad.
You may close the policy and invest in MFs. Early closure will cause a heavy loss, but it is a price worth paying rather than continuing with a bad product. You may finally end-up making better returns in a good mix of funds.
Case 2: You have not yet paid the first 3 years’ premium
Insurance laws stipulate that if the policy premiums are not paid for at least 3 years, the surrender value will be zero. So, one or two premiums paid so far will be a complete loss.
Hence, now the choice is between
(a) whether to forgo the premiums paid till date or
(b) pay up to 3 premiums and then take a decision.
Analyse assuming you have paid 3 premiums and see how it looks. If the decision was to exit, then it may be better to forgo the premiums as a total loss. However, if the decision was to stay, then go ahead and pay at least the 3 premiums. However, in most ULIPs, it may work out that paying at least 3 premiums is a better option