ETMutulFunds.com receives several messages from our readers on our Facebook page everyday. At least a few of them are related to ULIPs or Unit Linked Insurance Plans. Surprisingly, most of these ULIP owners believe they have invested in a mutual fund scheme. Most often they are surprised when we point it out to them that they have bought an insurance product, and we will not be able to offer a detailed response because we run a mutual fund forum.
Sure, insurance companies and their sales forces used to sell ULIPs as an investment product during the initial years of privatisation of the insurance sector. The first generation ULIPs had a hefty commission structure. Often, insurance agents used to pocket around 60% of the first premium as commission. Rampant mis-selling finally attracted regulator’s attention and the second generation ULIPs with lower commissions and larger insurance cover were rolled out. Since then ULIPs have gotten better. However, misselling of these products continue even to this day.
ULIPs are sold as bonds by many relationship managers at banks. Some intermediaries sell them mutual funds that offers guaranteed returns after five years and fee insurance cover.
So, what exactly is a Unit Linked Insurance Plan or ULIP?
Simply put, a ULIP is an insurance product with an investment element in it. Or, as some insurance agents claim, it is like a mutual fund scheme with an insurance element in it.
Confused? It is not surprising because that is the way insurance has been sold in India. During the monopolicy of Life Insurance Corporation of India (LIC), insurance cover, as we knew, always had an insurance cover plus savings element in it. That is why insurance was always about compulsory saving plus tax saving. You may invest x amount and you will get X plus bonus. That is how insurance was sold before privatisation. Endowment plans or insurance products with savings used to dominate the scene at that time.
After privatisation, the insurance cover started coming with investments in them. And investment options ranged from conservative fixed income to highly risky equity. That is the history of ULIPs for you.
Here is how these plans work. You pay a premium for your insurance cover. The insurance company deduct the money for life cover and other expenses and invest the rest of the money. In the earlier endowment plans, the investments were usually in traditional fixed income instruments. In ULIPs, you can choose your investment options, but mostly people without knowing chose stocks.
Now, why do we say ULIP is a bad investment option? Simple. Mixing insurance needs with investment is a very bad idea. The idea behind securing a large insurance cover is to take care of your family after your death. Insurance plans with savings or investments element in them will not help you obtain a large insurance cover. You will have to pay a very large premium to get an adequate insurance cover. Most individuals will not have enough money to pay the premium. Even if they do, they will not have anything left to take care of their investment needs.
So, what is the way out. You should always opt for pure term insurance plans to buy a life insurance cover. Pure term insurance only offers insurance cover and it doesn’t have any savings or investment element in it. So, you can buy a very large life insurance cover through a pure term plan by paying a very small premium. If you die during the term of the cover, your dependents will get the insurance cover. If you outlive the policy, you will not get anything.
Not getting anything or losing the premium paid is something most Indians can digest. That is why insurance companies pushed for insurance plus savings or investments, and Indians happily opted for such expensive products like endowment plans and ULIPs.
Once you secure an adequate life cover, you can invest in mutual funds to take care of your investment needs..
What is the advantage of this strategy. One, you managed to buy an adequate by paying a small premium. Next, you can keep track of the performance of your mutual fund schemes and take appropriate actions if they flater. You will not be able to do this with an insurance plan like ULIP. If the investment part is not performing well, you can only switch to another investment option. Selling out completely is not an option as you will lose your insurance cover. And getting a life insurance cover becomes expensive and cumbersome as you become older.