With the stock markets barometers Sensex and Nifty touching new highs, individuals are increasingly investing in unit-linked insurance plans (Ulips) offered by life insurance companies. Such products offer market-linked wealth creation while providing security of a life cover. While the premium is invested in equity and debt markets, such products come with high costs because of the various charges levied by life insurance companies, which shrink the investible portion of the premium paid. The returns depend on the performance of the fund.
Market risks
So, unlike traditional products, Ulips are subject to market risk, which affect the fund’s net asset value (NAV) daily and the returns are not guaranteed by the insurer. Such products have a lock-in period of five years. During this time, an investor cannot redeem the money. In mutual funds, equity-linked savings schemes have a three-year lock-in period. The amount invested in Ulip is eligible for tax deduction under Section 80C subject to a maximum of `1.5 lakh a year but with the condition that premium should not exceed 10% of the sum assured. One can invest in Ulips for long-term goals financial needs like retirement, higher education of children and their marriage.
Charges capped by Irdai
The insurance regulator had capped the charges for Ulips. Excluding mortality charges—the cost of life insurance cover—the maximum reduction in yield will be 4% in the first five years, it will be 3% for 5 to 10 years and will be 2.25% after the tenth year. Maximum reduction in yield means the maximum amount an investor’s gross returns can go down after factoring in all the charges.
Before investing in Ulips an investor must understand the charges that he will have to pay over the entire tenure. Insurers charge for premium allocation, policy administration, fund management, mortality, surrender/ discontinuance, rider, switching, top-up, etc. Lower the charges of the plan, higher the premium invested and higher will be the fund value in the long-run. So, at the time of choosing the product, compare the charges and pick the one which has the lowest cost structure.
Premium allocation charge
The premium allocation charge is directly deducted from the premium paid by the policyholder for allocating the units under the policy. It is charged by the insurance company to recover expenses incurred in processing the policy such as cost of underwriting, medical examinations and expenses and distributor fees. The balance amount is invested in the fund and units allocated as per the NAV. Ideally, look for an online plan which will have lower premium allocation charge than the one offered by the distributor.
Mortality charge
Life insurers charge an amount for providing the insurance cover. Called mortality charges, it compensates the company in case the policyholder doesn’t live to the assumed age. The amount will vary depending on the amount of life cover and the age of the insured. Even factors like gender—higher for men—location, financial status, and occupation of the insured will impact the mortality rate.The mortality charge is calculated per thousand of sum at risk. So, higher the sum at risk, higher will be the charge. Also, greater the age, greater would be mortality charges on the Ulips. Mortality charge is higher for Ulips as compared with term plans. Typically, it forms 6-10% of the premium and is the highest in Ulips. It is charged every month and deducted from the policyholder’s fund value.
Fund management charge
This is deducted towards managing the fund and is levied as a percentage of the value of assets. It is deducted by the insurer before arriving at the NAV. As it is levied on the accumulated amount, as the corpus grows, the actual amount deducted will also increase. As per regulatory norms, insurers cannot levy fund management charges more than 1.5%. Debt-oriented linked-plans have a much lower fund management fee than equity-oriented plans. Analysts say policyholders should look at cost structure carefully before investing in Ulips as higher costs will reduce the value of the fund in the long-run. For pure investing purpose, Brijesh Damodaran, managing partner of BellWether Advisors LLP advises that one should opt for mutual funds as the expense ratios in equity funds is 1.5-3% and in debt funds it is usually much lower.
