UNDERSTANDING ULIPS

Insurance is usually bought by an investor seeking to transfer risk from an individual to a pool to protect against untoward incidents and to provide for monetary compensation to his family. With the introduction of ULIPs, investment plans vended by insurance companies, this logic has been turned on its head. Unit linked insurance plans (ULIPs) are pitched as an investment product rather than as a risk shield and it is the unit holder who bears the risk of market swings in these products.
While insurance companies pitch ULIPs as a product for the long term, there is considerable mis-selling of ULIPs in today’s market scenario and many investors sign up for ULIPs without really understanding their risks. Here are some points about ULIPs that your agent probably won’t tell you:
Guaranteed vs illustrative returns: Many ULIPs are today marketed as products that offer a “certain” return over a specific time period. “Invest Rs 15,000 and double your money in five years”, is the kind of pitch often used to sell ULIPs. But investors need to distinguish between an “illustration” provided by an agent (which is based on assumptions) and an actual “guarantee” by an insurer. If the product is a ULIP, it carries market risks — usually there are options of investing in various proportions of equity and debt, based on the individual’s risk appetite.
There can be no assured returns possible unless the insurer states guarantee in the offer document of the product.If you are invested in the pure equity option for a ULIP, it requires you to monitor the performance of equity markets closely, especially closer to the goal. It’s always advisable to switch a sizable portion of the fund value to debt at least a couple of years ahead of the goal, to protect the corpus.
Paperwork is important: The Insurance Regulatory Development Authority (IRDA) makes it mandatory for every insurer to provide an illustration to accompany every ULIP sold. This illustration should project returns assuming 6 and 10 per cent annualised returns and take the signature of the policy holder on the same. Unitholders should note that the “returns” shown in the illustration are based on assumptions and may or may not really materialise. They also need to note that their effective returns will be reduced by expenses.
In general, for a 10-year plan, the net effective returns will be between 5.5 and 6.0 per cent, net of expenses charged, if the plan earns annualised returns of 10 per cent. Returns are higher if the plan has a maturity beyond 10 years.
If one reads the product brochure closely, one will find various expenses such as premium allocation charges, policy administration charges, mortality charges and fund management charges in a ULIP. If a fund charges 0.80 per cent as fund management charge, it has potential to deliver much higher returns than one charging 1.25 per cent, even if the premium allocation charge is lower in the latter case.
The expense structure also implies that ULIPs are meant only for long-term goals and are not a good avenue for the short term. Marketing agents often try to sell ULIPs as three-year products and suggest you withdraw the proceeds at the end of three years. But that is a surefire way to lose money as expenses will be particularly high in the initial years and surrender charges also may apply for premature termination!
One reader cites an instance where he paid premiums for three years in a ULIP totalling Rs 52,000. When he approached the insurer to surrender his policy, he was informed that he would receive only Rs 19,800!
Use the switches and redirection: Those who buy ULIPs should understand the importance of switches and redirection options that come with the product. These two options are very useful in protecting the corpus in a highly volatile market.
Switches come in handy in turbulent times such as the past year. If you are worried about stock markets steadily declining, you can shift your accumulation from equity to debt plans without any charge. Similarly, in those periods where your renewal premiums are due, you can give direction to the insurance company to invest the fresh premium in the debt option.
Claims can be repudiated: ULIP products usually bundle a life cover with investments, but remember that claims can be repudiated if you’ve not met the formalities correctly. One insurance player points out that the repudiation ratio (claim ratio in death) is as high as 20-30 per cent of the total claims, mainly due to non-disclosure facts.
This generally arises in cases where the agent fills in the application form. Though it is not wrong for an agent to fill the application form on your behalf, the policy holder has to understand the importance of the medical questionnaire that comes as part of the application form.
The family case history, your occupation, place of work, pre-existing diseases and your life style risks (e.g. if you consume alcohol, the frequency) all are very important for the underwriter (read as insurance company) to evaluate your risk profile.
So, leaving these details to the agent and simply signing on the dotted line exposes you to the risk of the claim not being met, when the time comes. It is mandatory to go through these clauses and get clarifications from the agent before writing out your cheque for the first premium.
If you have mis-stated some points you still will have fifteen days’ grace period from the date of receiving the policy document to rectify them. But if you want to return your policy at this point, you will incur some charges.
Orphan policy holder: If your insurance agent moves out from one insurance company to another or stops working for the insurance company, you, as a policy holder, will not be in a position to use the services of the agent.
That may lead to your missing out on renewal premia and forfeiting the policy. Of late, due to increase in lapsation rates, insurers are trying to reach out to policy holders directly, to remind them to pay the renewal premium.
One good way to avoid lapsation of policy is to opt for ECS debits for the premium amount. It is also mandatory for one to inform the insurance company immediately if there is a change in the communication address.