With the markets around 20,000 levels there is an upbeat sentiment among investors. The bull-run has become the buzzword and financial dailies are agog with stories of market hitting new highs. Business news channels are next only to daily soaps when it comes to TRP ratings. There are some folks busy analysing the reasons behind this ascendance and there are some who are trying to foresee what is in the offing. But most others are trying their best to pick up their share of the cake.

On the one hand there are some experts who are continuously warning investors to be wary of speculative bets and to rationalise their expectations. On the other hand, there is a rise in the number of investors in the market. The direct equity investors and mutual fund investors are continuously rising. But a significant amount of increase in market participants is taking place through unit linked insurance plans (ULIP).

ULIP, undoubtedly the most successful financial product aimed at individuals, has been a miracle. It has not only attracted traditional mutual fund investors to the markets, but has also caught the fancy of those risk-averse investors who were not willing to accept mutual funds as an investment avenue, post tasting the US64 fiasco. Under the cover of ?saving tax? or for ?purchasing insurance? these shy boys are making their way to Dalal Street. In this tax-saving season of November, it is mandatory to take a look at ULIPs.

ULIP – the modern way

Unlike traditional products, the ULIPs are designed in such a way that you can ride the boom in the markets. Marked to market nature of investments and high level of transparency ensure that you come to know what is happening with your money, which was not the case with traditional products.

While buying a traditional life insurance product you will be asked about your sum assured needs and accordingly you were told about the premium. In ULIP, it works the other way round. First, you have to decide the amount of premium you intend to pay and accordingly you will be offered a sum assured. Though, some of them offer you an option to buy additional sum assured.

You also have the option to decide where your money should go, if you opt for ULIP. You can choose between equity and debt, whereas in traditional plans there is little freedom to decide where your money should be invested.

ULIP definitely scores over endowment plans, as the possibility of garnering higher returns is high, though with commensurate risks. It also offers you higher amount of flexibility in terms of payment of premium and asset allocation decisions. Higher liquidity is another area where ULIP beats a traditional endowment plan.

The benefits are compelling for most of us to go for it. The returns offered by ULIP are more than enough to see the ?benefits? involved in purchasing one.

The distributors are also more than keen to offer you one at your doorstep, if you have a deep pocket and there are almost no hurdles in buying process.

As Milton Friedman has rightly observed, ?There are no free lunches in this world.? You have to pay for the benefits you are getting in ULIP. The biggest issue with ULIP is its complex nature, leading to poor understanding of product functionality and the costs associated with it amongst buyers. At a time when the objective of ?riding the bull-run? is expected to undergo ?rationalisation?, it becomes imperative to have a look at the costs and their impact on the product functionality.

Mortality charges

Mortality charges, the cost of insuring your life that you pay to a life insurance company, is the first on the list. Using these monies the company provides you a sum assured that is payable to the nominees in case of an eventuality.

In most plans, in case of death of the life assured, the insurer pays the nominee higher of the sum assured or the value of accumulated units. Hence in the initial years as your accumulated units? value is less than the sum assured, mortality charges tend to be on the higher side compared to later years.

This is primarily because, as you go along, the premiums keep purchasing more units and the accumulated units are also expected to rise as the market rises. As you move closer to the sum assured, your mortality charges go down as the sum at risk falls. If the units? value exceeds the sum assured then you need not have to pay mortality charges.

You may come across many who will tell you that they are enjoying insurance cover for free. But this is far from reality. Also, some of your friends may tell you that they are paying almost negligible amount towards mortality charges. But please note that this state is attained over a long period of time as the sum assured reduces to a very small amount.

As the sum at risk keeps fluctuating with the markets, your outgo towards insurance will remain volatile. In other words, if the mortality costs are expected to fall in the rising markets, you cannot rule out an event of rise in mortality costs due to fall in units? value owing to a fall in the markets in the short term. It may not be a unidirectional bet. An important factor to note is that the cost of insurance keeps on rising with your age. If you are above 50 years of age and entering a ULIP just to make a ?tax-saving investment with good returns?, be careful. The mortality charges will eat into your returns.

There are some ULIP that offer you both, sum assured and fund value, in case of an eventuality. Here you have to pay for the entire sum assured and the costs keep rising as your age advances.

The costs

All life insurance companies incur some costs on account of administration and sales and marketing. Administration costs are expressed in absolute terms like Rs 65 and will be levied on a monthly basis. In some cases, you may come across it as a percentage of the premium paid. Do take the trouble to check if the administration costs are allowed to increase at a stipulated rate to allow for inflation. If you come across a benefit illustration, do ask if the administration costs are adjusted for inflation. If not, please confirm if they remain stable throughout the policy term.

The sales and marketing charges include the commission paid to the agents. In the first year the commissions range from 7% to 25% of the premium paid. In some cases this may exceed. In the later years, however, commissions fall.

In many ULIPs, you come across a term called ?allocation charges.? These allocation charges take care of the sales and marketing and other incidental charges.

Fund management fees

You are offered with multiple investment options in ULIP. The growth, aggressive or maximiser option invest in equities and are ideal for high-risk high return psyche. On the other hand, the income or moderate option invests in debt instruments having varying maturities and varying credit profiles offering good inflation adjusted returns with moderate risks in the long run. The money market option, on the other hand, invests in call money and other money market funds offering low returns with low risks. Balanced options offering a mix of equity and debt are also available. All these funds come with some fund management fees and it is typically expressed as a percentage of corpus and of recurring nature. There are schemes that charge different fund management fees for each investment option. On the other hand, there are some schemes where a flat fund management fees as a percentage of corpus is charged irrespective of which option you are invested in.

The nature of this fee makes it imperative that the fee be as less as possible. Especially in the long run, if you progress from a high risk to low risk asset class (in other words, high return asset class to low return asset class) following your risk appetite, a flat fee of say 1% will make a significant impact. When you are making 20% on your corpus, it may not be pinching to pay 1%. But if you are making just 6% on your corpus, 1% is a large amount to fork out. Also, note that as your kitty rises, the costs in absolute terms go up. Here we end up with mandatory costs. There are some conditional costs that you may incur.

Other costs

As a ULIP buyer, you are allowed to transfer your money from one asset class to the other. For this purpose the insurer may offer you a stipulated number of switches per policy year free of cost. But once you exploit all the free switches, you have to pay for every subsequent switch.

Just because you have a number of free switches, don?t try to time the market. Switch is provided to you to ensure that you can take care of your asset allocation at stipulated intervals -such as once in a year. Though, if you lose ?comfort? with an asset class you can consider a switch.

Top-up charges are the charges you have to pay if you intend to invest in excess of the stipulated premium. Top-up charges are expressed as a percentage of the amount invested and is lower compared to the allocation charges of the original premium. If you intend to surrender the policy before a stipulated period, you have to pay a charge termed as surrender charge. This is primarily to discourage early withdrawal. In case of surrender in the early years of the policy, you tend to lose.

The way out

Though the costs make it a complicated play, you can still make the best of this product. How you go about buying a ULIP is important. You have to focus more on your needs than the benefits offered by ULIP. The need analysis will tell you if you need life insurance; if yes, how much and what is the time horizon of it.

Let?s take a simple case. If you are 35 years of age and have just bought a house on loan and the loan outstanding is Rs 50 lakh, you need a life insurance in excess of or at least equivalent of this liability. Consider buying an insurance of Rs 50 lakh through ULIP and your premium outgo will be in a few lakh. If at all you can afford this, the pinch is big enough. On the other hand, if you decide to purchase a term insurance for Rs 50 lakh you will be paying a very small amount compared to the ULIP premium.

For those looking for pure investment products, consider mutual funds or other investment products. ULIP is first a life insurance provider and then an investment product. As pointed out earlier, mortality costs attached can eat into your returns. For those who have already bought ample life insurance and are in the later years of their earning life, there is no need to follow the herd. There are instance where ULIP is bought just to take the equity plunge. If you have played your innings well and have built a good retirement kitty there is no need to venture into unchartered (risky) territories.

For those who need both savings and life insurance, ULIP is one of the good options available provided you have a long-term view. There are many instances where ULIP is sold with a three-year horizon. You should note that the premium holiday offers you the premium paying flexibility and not the way you should go. The true benefits of the product accrue only in the long run. Some ULIPs also allow partial withdrawal after three years. However, such withdrawal should be avoided.

There are instance observed that an individual purchases different ULIP schemes floated by the same insurance company. This is primarily done to avoid purchasing ?costly? units of old schemes. Here, the NAV being high or low does not make any difference. Both the schemes invest in the same equity market and the returns in the long run should be more or less in line with the broad market. High NAV is not a bad thing; rather it speaks about the performance of the fund manager. Also, when you buy a new scheme, you end up paying high costs, as the costs are higher in the initial years.

Regular premium plans are aggressively marketed as distributors get higher commissions compared to that of single premium ULIP. However, due to lower costs in the first year, you get an opportunity to enjoy the same set of benefits at better terms. There are single-premium ULIPs where the money invested in the market is as high as 98% of the premium. In top-up cases, over the long term the regular premium ULIP may be better a option than their single premium counterparts. Also, you have to be a regular and disciplined investor. Further, your sum assured in such cases will have to go up as per norms.

Life insurance companies are not facing redemption pressure as the market experiences volatility. This is a big positive for fund mangers of insurers. This is in line with the global observation of high stickiness of insurance money. More the stickiness of money, better it is for fund managers as they can remain invested in long-term themes and can enjoy the ride in due course. In India ULIPs are in the nascent stage and there are few redemptions/ partial withdrawals now, offering ULIP buyers an edge over mutual fund investors.

There are instances where you come across some promotional material showing how quickly you will reach the 1 crore mark or 10 crore mark. Instead of solely taking the number in mind, do ponder over how that number is arrived. Check out what is on offer from competition, and then decide which way you want to take. After all, it is your money that is being invested and it is you, who will ultimately lose or gain out of all this game.