Buying ULIPs? Read the fine print

Buying ULIPs? Read the fine print


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.

Boundaries

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.

The trade-off

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
stock market, the premium guarantee plans could be the answer. In the long
run, expect a return in the range of a balanced fund.

Happy Investing