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Buying ULIPs? Read the fine print
Sunil Dhawan, Outlook Money | March 22, 2007
Till a few years back, a return guaranteed on an insurance policy was a good enough reason for you to maybe buy that policy. During the monopolistic era of Life Insurance Corporation of India, a majority of their policies had a return guaranteed in them. High interest rates during that time also saw a deluge of similar policies.
Instead of declaring bonuses based on the profit, if the insurer fixes a return right at the beginning of the term for the entire duration, bonuses take the place of guaranteed addition. In such circumstances, whatever the profits of the insurer, it has to pay an assured return on those polices.
Slowly, with falling interest rates, policies with such promises also faded away. Since 2001, when private insurance companies came on to the battlefield of premiums and sum assured, guaranteed returns plans went out of favour. Its long-held position was taken over by the more flexible unit-linked insurance plan.
Despite this, guarantees have sneaked back into the insurance industry. In our exercise, we have considered guarantees provided in unit-linked plans only and looked at various options available. The guaranteed returns or additions in a participatory or a with-profit policy is a fixed sum of, say, Rs 60 per Rs 1,000 of sum assured, that gets attached to the policy every year till the end of the term. A higher guaranteed addition does not necessarily mean a higher return. The internal rate of return or the actual effective return of that policy may still be low.
Why such guarantees?
Unit-linked plans by their very nature are subject to market fluctuations. The investment risk is entirely the investor's, as are its gains and losses. In the long term, these risks are expected to even out and returns over a period of more than 10 years are likely to be around 12-15 per cent. However, if you feel that at least a certain amount of return should be guaranteed or at least your principal should be safe, this option is now available.
In the ULIP sphere, two kinds of guarantees are offered - on the premiums paid and of the premiums paid.
Returns assured 'on' your premiums: Although few companies provide guaranteed return on the premiums that you pay, this assurance is not on the entire premium that is invested. The guarantee is always on the net premium that is invested after deducting certain charges from it.
For example, Flexi Save Plus, Flexi Life Line and Flexi Cashflow are few plans from Birla Sun Life Insurance that come with such guarantees. Minimum guaranteed return of three per cent per annum is on the premium and any top up amounts after deducting all the policy charges from the premium invested. A return generated in excess of this is for the investor to enjoy.
At the time of maturity, the higher of the fund value (constituting the actual return generated) or the guaranteed fund value (based on three per cent net returns) is paid to you. Similarly, on death, the nominee receives a higher of the fund value or guaranteed fund or the sum assured.
These plans have different terms and you can also limit the premium payment to a lower duration. For example, someone choosing to buy a 25-year plan may pay premiums only for 15 years while the policy continues till 25 years. The expenses also differ based on the tenure of the policy you choose.
For example, in Flexi Cash Flow if the premium paying period is kept at 15 years, the charges would be 65 per cent of the first year premium, 7.5 per cent for next two years and five per cent for subsequent years. This means that a premium of Rs 50,000 in the first year gets reduced by Rs 32,500 and only the balance of Rs 17,500 is invested.
Here, you need to note that the guarantee is on Rs 17,500 and not on the actual amount invested. Other policy charges could further reduce the net amount. The effective guaranteed rate is actually around one per cent.
Assurance 'of' your premiums: Aviva Life Insurance has a slightly different kind of guarantee across most of its policies. Of the three fund options - growth, balanced and secure funds - the guarantee is that on maturity, the fund value of the secure fund will not be less than the price of units as and when purchased through paying of premiums. This gives an assurance that even if the market goes down, the principal invested is safe and would never erode. The stipulation: there should not be any switch to or from the secure fund in any year.
Here, you need to take note of the fund composition, which has a range of 60-100 per cent for debt securities, up to 20 per cent for equities and equal percentage for money market instruments. The return as on 22 February, over the last one year in its secure fund has been around seven per cent with equity exposure of just eight per cent of the total corpus. This is an option for investors looking to park their funds after exhausting the Rs 70,000 limit in a public provident fund.
ICICI Prudential and Reliance Life Insurance also offer plans that carry a guarantee of the premiums that you pay. The sum total of all premiums paid is guaranteed on death or on maturity of the plan. Here, assurance is on the entire premium paid and not just of the net premium.
Invest Shield Life with maximum equity exposure of 40 per cent and Invest Shield Cashback with zero percent in equities, are two such plans from ICICI Prudential. Reliance Life Insurance has Money Guarantee Plan in this sphere with equity exposure ranging between 40 and 60 per cent as per your choice.
No guarantee comes unconditionally. One feature in almost all Ulips is the cover continuance option. Under this, if one is not able to pay the premiums anytime after paying for the first three years, your policy would not lapse and the life cover continues.
The life cover sustains because of the mortality charges (life coverage charges) that continue to be deducted from your fund value. In order to avail the premium guarantee benefit, one needs to make sure that all premiums have been paid and the cover continuance option is not being used at all. A single missed premium will bereave you of this guarantee.
Another similarity lies in the maximum equity exposure that these plans take. Do not expect to ride the equity wave when the markets are in full swing, as a maximum of about 60 per cent of your money would be invested in equity depending on the insurer.
In plans where premiums are guaranteed, charges over the years are slightly higher than a plan without any such guarantees. The fund management charge may be slightly lower as the exposure to equities is not high. As on 31 December 2006, the one-year return in ICICI Prudential Invest Shield Life Plan was 17.62 per cent, which had an equity exposure of just 27.37 per cent. Compared to that, the returns of the Maximiser Fund of the same insurer, which had 97.91 per cent exposure to equity, in the same period was 36.56 per cent. The low equity dimension keeps the returns on the lower side.
Should you invest
ULIPs are bundled products that simultaneously take care of your investment and insurance needs. Buying them separately would cost you less. Make sure you hold a ULIP for a horizon of not less than eight to 10 years to actually derive its advantage. Be clear of the portfolio composition. Risk coverage of both - one's life and the capital invested - is something these plans attempt to offer. If you are looking to take moderate risk and willing to expose your neck a little into the stockmarket, the premium guarantee plans could be the answer. In the long run, expect a return in the range of a balanced fund.