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Buying Ulips? Beware of this trick
Chandnee Sinha | June 06, 2007 13:22 IST
Insurance agents (Oops, 'advisor' is the word they use these days) use various tricks to sell Unit Linked Insurance Plans (Ulips) to the unsuspecting customers.
One standard trick used is telling the customer that he needs to pay premium for only three years and the policy still continues for the remaining tenure. This as we will see below is not in the best interests of the individual buying the Ulip.
A Ulip has both investment and insurance features. A part of the premium is invested and another part goes towards paying the mortality charge for the insurance that an individual taking a Ulip receives. The part that is invested can be invested in 100% debt, 100% equity or various combinations of debt or equity.
Most Ulips give an individual four to six investment options. For the amount that is invested, as is the case, with mutual funds, units are issued at the prevailing net asset value of a single unit. Most Ulips have tenures of ten years and above, though there are some Ulips in the market which have a tenure of as low as five years.
All Ulips come with what is known as a 'cover continuance' option. This option has to be chosen at the time of starting the policy. The option ensures that if due to some reason the individual taking the policy is unable to continue paying premiums after paying premiums for the first three years, even then the policy continues.
It is an option built into the policy to help those who face a financial crunch few years into the insurance policy and are unable to keep paying the premium in the years to come.
Insurance agents, never short of creating an opportunity to sell where none exists, have converted the presence of a cover continuance option in every Ulip policy into a selling point. They tell their customers that they can stop paying their premiums after three years.
Hence individuals who have the capability to keep paying premiums even after three years are under the impression that they don't need to pay premiums after three years.
Now this is not really in their best interests. The main reason for this being that most Ulips have very high charges for the first two to three years.
In the first year, 15-71% of the premium can be deducted as a premium allocation charge, depending on which insurance company the individual goes to. What this means is that if an individual decides to pay a premium of Rs 60,000 per annum and the premium allocation charge for the first year is 35%, then only Rs 42,250 will be invested. The remaining Rs 17,750 will be recovered by the insurance company as a premium allocation charge.
If in the second year, 20% of the premium paid is deducted as premium allocation charge, then Rs 47,000 of the premium paid of Rs 60,000 is invested. The remaining Rs 13,000 is deducted as a premium allocation charge.
Most of this high premium allocation charge is passed onto an insurance agent as commission. From third year onwards most Ulips have a premium allocation charge anywhere from 2%to 5%.
So the point to understand here is that individuals who stop paying the premium after the third year affectively give away the advantage of lower premium allocation charges for the remaining tenure of the policy.
A lower premium allocation charge ensures that a much larger portion of the premium is invested and helps the individual build a bigger corpus of money. By stopping to pay premiums after three years, the individual essentially pays the higher premium allocation charge and ends up with a small corpus.
Other than this, individuals who stop paying premiums after three years also run the risk of the policy being terminated. The individual may have stopped paying the premium but that does not stop the insurance company from recovering other charges like the mortality charge, fund management charge, policy administration charge, etc. These charges are usually recovered by canceling units that the individual has accumulated.
A policy on which premium is no longer being paid can continue till the value of the investment is greater than one year's premium. If it falls below the one year's premium then the policy is ended and the amount returned to the individual.
Now the bigger question is why do insurance agents tell people that they can get out of the policy in three years?
The major reason for the same is that after three years the agent can hope to sell another Ulip to the same individual. The commission that an insurance agent earns on the policy in the first year is much higher vis a vis the commission that he earns in the latter years of the policy.
The other reason is that most individuals do not like policies in which they are locked in for long periods of time. Hence, the easier way to sell them a Ulip is by telling them that they need to pay a premium only for three years.