Sunday , 25 June 2017

Guaranteed ULIPs: What are they?

SINCE their launch, Unit Linked Insurance Plans (ULIP) have been a complete rage; but that’s not the case now. This year, thanks to the slowdown, insurers are seeing lower premium income compared to last year.

So to maintain the spark in ULIPs, insurance companies are trying to entice buyers by offering guaranteed returns on ULIPs!

How’s that possible? Let’s decode.

As of now almost all insurance companies are offering guaranteed ULIPs, some plans are named below:

SBI Life Insurance Smart ULIP
Birla Sun Life Insurance Platinum Plus II
Tata AIG Life Insurance InvestAssure Apex

Unlike non-guaranteed ULIPs, these newly launched plans shield you from the downside of the market by assuring guaranteed returns.

He explains that these plans are like investing in fixed income products that offer secured returns.

Workings of the plan:
These plans are structured into four phases.

Subscription phase: During this phase, the plan is open for a limited time only.

Premium paying phase: In this phase, you pay premium only for a fixed term, which is 3 years. However, SBI’s Smart ULIP allows you to choose the premium paying term for 3 or 5 years.

NAV build-up phase: During this phase, the reset dates, set by the companies are exercised. Reset dates are pre-decided dates fixed by insurance companies to record NAVs. Birla Sun Life and Tata AIG record NAV once a month on the reset date decided by them whereas SBI has two reset dates every month to record NAV.

These plans have a fixed term of 10 years.

Accumulation phase: The remaining policy term i.e. the tenure left after all the reset dates have been exercised is the accumulation phase.

What’s unique about guaranteed ULIPs is that they offer the highest Net Asset Value (NAV) recorded over a given a period of time.

Maturity benefits: On maturity, you get the highest of:

a. The fund value as on date of maturity OR
b. The fund value at the rate of ‘highest recorded NAV’ OR
c. The starting NAV of Rs 10 per unit

The is highest recorded NAV is the higest NAV among all reset dates.

Death benefits: In case of your untimely death, either fund value or sum assured will be paid out to your nominee, depending on whichever is higher

What should you watch out for?
1. Charges are more:
When you compare guaranteed ULIPs to single premium or limited premium paying term plans, the charges on the former are on the higher side. The table below explains this. It shows the net amount invested at the end of three years after deducting the policy allocation charges. The sum assured for the plan is assumed to be Rs 5 lakh and premium Rs 1 lakh.

SBI Life Insurance Birla Sunlife Insurance Tata AIG Life Insurance
Policy year Smart ULIP Platinum Plus II InvestAssure Apex
Policy term of the plan 10 years 10 years 10 years
Year 1 15 10 9.5
Year 2 5 4 4
Year 3 5 4 4
Net investment
at the end of
3 years
Rs 272,800 Rs 265,800 Rs 88,060
Policy year SBI Elite Gold Plus II InvestAssure Plus
Policy term of the plan 10 years 8 years 15-30 years
Year 1 10 8 9.5
Year 2 7 4
Year 3 7 4
Net investment
at the end of
3 years
Rs 275,400 Rs 276,306 Rs 96,750


Note: The calculation for Tata AIG has been done taking into account the charges for 1st year only because InvestAssure Plus is a single premium product. However, for information purpose, Invest Assure Apex shows figures for 2nd and 3rd years also.

2. Limited option in hands of investor
These plans don’t have a switching option. They also have only one choice of fund that invests in a mix of debt and equity. An investor is at the mercy of the fund manager because on one hand, his money is locked in while on the other, he has not flexibility to switch.

If you want to invest in safe avenues there are better options like public provident fund, bank deposits; why pay a charge for it.” And anyway, “It’s always better to keep your insurance and investment needs separate.”

These schemes come with a lock in of 7-15 years wherein you’ll be able to redeem your investments at an NAV which was highest during these 7 years. Let’s say, the NAV of the scheme was Rs 75 in the 6th year but during the time of redemption it comes down to Rs 65; however you will not be impacted by this fall since your investments will be redeemed at Rs 75.

You also have the option of choosing a suitable asset allocation—you can distribute 0% – 100% in equity, debt or money market instruments in any proportions.

Most companies tend to adopt capital protection strategies like Constant Proportion Portfolio Insurance (CPPI). These models ensure that your fund takes only as much risk as needed to keep the final value of your portfolio intact. This could result in the returns being lower than market returns or in worst case scenario ensure only capital protection. There is no free lunch after all!
The capital protection model decides the risk which the fund will be able to absorb given the interest rates in market and the duration. In the event of a downside, the company can hold onto equity only till that value where risk is completely utilised and then the whole fund will be transferred to debt.

There have been cases when this got triggered closer to the market low and money got locked in to debt because the fund has to regain the lost money so as to protect the capital.

This is how it will work…

  NFO  Rs 10
 Risk Appetite  30%

Case 1 – Market rallies higher and higher

Equity exposure Rs 10
 Market rises – high nav  Rs 15
 Interest rates  7%
 Time to maturity  4 rs
How capital is protected  In case fund falls more than 7%*4= 28%, the fund is transferred to debt ensuring maturity value of Rs 15 through the debt instrument.

In case the market does not recover back to the original high, then the product will outperform the market. If on the other hand, there is a fall of 28% and subsequently the markets surpasses the earlier peak, the fund would underperform.

Case 2 – Market slides

Equity exposure  Rs 10
 Market rises – high nav  Rs 11
 Interest rates  7%
 Time to maturity  6 yrs
 How capital is protected  In case fund falls more than 7%*6= 42%, the fund is transferred to debt ensuring maturity value of Rs 11 through the debt instrument.

In this case, it is possible that market recovers the full fall and ends the 6th year with a significantly higher return, the investor would then lose out on the upside.

Key takeaways

  • When should you invest? If money is invested when the market is rising or near to bottom the performance will be satisfactory since they start by investing first in equity and then transfer the same to debt on a market fall.
  • When should you not invest? When the markets are nearing its high or there is a potential of drastic fall, then you should stay away.
  • Who should invest? This fund is for those who want don’t want to be exposed to higher risk but are looking for a bit of capital appreciation along with safety. This can be used by investors who are new to the market and may be operating with insufficient information and expertise.
  • How much return to expect? The way this product is structured it should provide you with returns similar to balanced funds; somewhere between the returns that can be expected from debt funds and equity markets. However, there are scenarios in which the fund can significantly outperform or underperform.
  • How much is the risk factor? At the most an investor might not be rewarded with returns and at maturity he gets back only the capital invested. The other risk is that the fund underperforms the markets.
  • What are the drawbacks? The drawbacks are as follow

-Do not provide range of products depending on risk profile.
-Charges levied are higher than normal products.
-Capital protection or highest NAV guaranteed only at maturity.

So does this mean that this product class should be a complete no-no? One needs to understand an investment product before assuming anything about it. This product is suitable for those classes of people who want income from equity products but their risk appetite is not high. However do keep in mind that while highest NAV is guaranteed, the highest return isn’t!

IT’S human tendency to choose one product over the other, simply because it carries a ‘guarantee’.

For a few years now, investments (some unit linked insurance plans and mutual fund schemes) have been coming with a guarantee. But you probably didn’t pay heed, because the stock markets were booming and you didn’t need a guarantee. But now that the tide has turned, you will find mutual fund agents and insurance advisors flocking to you with guaranteed schemes.

But before your agent lures you into buying a capital guaranteed product (CGP), go through the following dialogue with a CGP.

Me: “Hello. I hear you are a capital guaranteed scheme.”
CGP: “Yes, you heard that right!”

Me: “So, how do you function?”
CGP: “Quite simple! You invest your money – any amount you wish to. I guarantee that your capital will remain intact, even in the worse case scenario, that is, you get your money back 100 per cent. Plus, you can even earn returns, no matter what the stock market does.”

Me: “Are you going to invest my money in the stock market?”
CGP: “Yes”

Me: “Then how can you give me a guarantee? Stock markets are so volatile after all.”
CGP: “Actually, we invest your money based on the number of years that the product is offered for. For instance, assume you invest Rs 100 for five years. I divide your money in a 70:30 ratio. I invest the 70 per cent in a debt instrument, that is, bonds etc. Assume that these bonds give a return of 9 per cent per annum, that is Rs 6.3 (Rs 70 x 9 per cent). So, in five years, I make Rs 31.5 for you.

So, when I add the Rs 70 of your investment + Rs 31.5, you get a total of Rs 101.5. This is more than your initial investment of Rs 100. This way I ensure that your capital is protected.”

Me: “And what about the balance 30 per cent?”
CGP: “I invest that money in the stock market. So, if in five years time the stock market doubles, so does your investment. Hence, your Rs 30 becomes Rs 60 and you make a neat profit of Rs 30. Thus, in total you have an opportunity to earn Rs 61.5 (Rs 31.5 + Rs 30) on an investment of Rs 100 in the best case scenario and Rs 31.5 in the worse case scenario. Sounds good?”

Me: “No it does not. It’s pathetic!”
CGP: “Why not?”

Me: “Getting Rs 161.5 in five years time is a return of 10.06 per cent on a compounded basis. And you say that is the best case scenario. In a worst case scenario, I do not earn any returns. I just get my capital back. Now, If I invest the entire Rs 100 into debt, I will make a guaranteed Rs 145 at the end of five years (assuming a 9 per cent return per annum). And that’s my worst case scenario!

Furthermore, If you are sure that the markets will double in five years, then i can invest all my Rs 100 in the market and get Rs 200 at the end of that period. So, my range of returns is Rs 145 to Rs 200 versus your range of Rs 100 to Rs 161.5. Why should I consider your proposition when i can make more money by investing elsewhere?”
CGP: “Well, you don’t want to choose stocks yourself and lose money right?”

Me: “I can invest in good equity mutual funds or perhaps an exchange traded fund which will give me market linked returns. I can even stick to blue chip shares. I have so many options.”
CGP: “What is the guarantee that you will be right? Plus, do you have the time?”

Me: “Well, i can put my money in two parts – in a diversified equity mutual fund and a debt mutual fund. Also, i can choose balanced funds which invest in debt and equity and entail lower risks.”
CGP: “You can choose but you are not assured of anything.”

Me: “Now that’s all marketing talk. Principally, why would I lose money if I hold for a long time, that is, five years. A balanced fund with a good track record is all I need. All this talk of CGP is really not worth my while.”
CGP is left speechless and simply leaves.

My advice: Scrupulous agents might pitch a capital guarantee scheme to you, especially in these volatile times. Shut your ears and invest in a good diversified equity scheme and ETFs for the long term.

The ULIP plans looks good when agents sell them, but the reality comes only when the policy documents reach to the customer and the final returns which the customer get.

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