The charges in ULIPs are difficult to understand and identified. We have to assess the charges levied in the ULIPs to know the long-term impact on investment even though IRDA has capped ULIP charges. Let us first accept one thing that all the financial products are sold through a mediator and agents will push the product more in which they are getting higher commission.
There are lots of arguments and discussion both in favour of and also against ULIP plans offered by Life Insurance Cos. Mutual fund Advisors will suggest their client to buy term insurance and put the balance amount in mutual fund schemes. They will always advice to keep insurance and investment separately. Insurance Agents, on the other hand, push ULIP plans as a combination of insurance and investment option with tax benefit. This tussle on the ground is likely to continue, but after government clarifying ULIPs as a insurance products, agent will have an upper hand.
The fact is insurance is a long-term product compared to Mutual Fund. The time horizon for buying an insurance product should not be less than 10 years. If your time horizon is lesser, than you should put your money in Mutual Fund Schemes and buy a term insurance plan. ULIPS are mostly missold to customer, either for lower premium term 5 years or for lower insurance cover i.e. 10 times of premiums paid. If you buy a life cover for a term more than 10 or up to your retirement and also you opt for maximum multiplier offered by the plan than it can be a good combination against term insurance and mutual fund, even though higher charges in initial years in ULIPs. Both have advantages and disadvantages, that depend upon time horizon, insurance cover opted for, premium payment term and goal for which you are buying the particular product.
Let us assess and compare the charges in ULIPs:
1) Allocation charges:
This charge is % of premium paid. Charge is very high in initial years mostly in first year and than it comes down to 2% or even nil, depend upon plan to plan. For e.g. you are buying a ULIP plan with an annual premium of Rs.30,000 and the allocation in the first year is 80% and from 2nd to 5th year is 94% and thereafter 99% till policy years. Than your charges for 1st year shall be Rs.6,000/-, 2nd to 5th year Rs.1800/- and Rs.300 thereafter till you pay the premium. If you stop paying premium afterwards than this charges are not applicable. Now in equity schemes of mutual funds, there is no entry load. So there are no charges like this. But before coming to conclusion you should also see other charges also.
2) Policy Administrative Charges:
This charge is either fix or are in % of either premium or insurance cover. The insurers have very smartly designed these charges. These charges also increase in some plans by certain % every year. Allocation charges are very easy to identify but this charges are very complex and difficult to understand. Many products came with 100% allocation and with no allocation charges and did very well in the market. All this plans had these hidden charges, which nobody noticed. Even today these types of plans are available in the market. This charge continues till your plan is alive even though you stop paying the premium. For e.g. we have to compare two different products in which one has PAC of Rs. 600 in first year and is inflating by 5% every year and other has 1.25% on the first opted life cover through out term. Your PAC, in 1st case, will be Rs. 600 first year, Rs.630 2nd year and Rs. 660 in third year and so on. It will increase by 5% every year. In 2nd case, suppose you are paying premium of Rs. 30,000 and have opted for 3 lacs sum assured. Than this charge will be 1.25% on sum assured i.e. Rs. 3,750 every year till your policy is alive.
3) Surrender Charges:
Liquidity is the major factor in deciding any investment avenue. Therefore, you should also know SC, before you buy an insurance plan. If you have not paid minimum 5 yearly premiums, the surrender charge will be more. It means all money, which you have paid, is largely forfeited as surrender charge. As per new guidelines of IRDA, there should not be any surrender charges after completion of 5 years. Still we have to be very cautious before finalizing ULIP. Before buying an insurance product, you must be sure at the beginning that you will be continuing the plan till end. Even though there is no surrender charge after 5 years, you will loose the money if the policy is surrendered, as it is difficult to cover the initial higher allocation charges in short term.
4) Mortality Charges:
This charge is nothing but the cost of insurance cover you have opted for. The major difference between term plan and ULIP is, in term plan level term premium is levied and in ULIPs it is levied as per the current age of the insured and increases every year as age increases. The cost of insurance is very low in initial years in ULIPs compared to term plan. For e.g. In ULIPS for person aged 30 years, the cost of insurance is approx Rs.130 per lakh whereas in term plan it is Rs. 250 to 300 per lakh. ULIPs also charges mortality rates on the balance sum assured i.e. actual sum assured minus present fund value. Mortality Charges are deducted monthly in ULIPs whereas in term plan you have to pay yearly premium in advance or if you opt for any other mode than your premium goes up by way of interest.
5) Fund Management Charges:
This charge is levied in % on the total fund value. This charge makes a lot of difference compared to mutual fund schemes. As per new guidelines by the IRDA, the FMC cannot be more than 1.35% in ULIPS where as this charge is approx up to 2% in equity schemes of mutual fund. This 0.50 to 0.65 % difference can make a huge difference in fund value if the time horizon is longer and also your investment is in lacs. For e.g. you are paying premium of 1 lakh every year and after ten years your fund value after deducting all expense is ULIP is approx. 20 lacs. The ULIP will charges you Rs. 27,000/- for that year. On the other hand, if you have the same corpus in mutual fund than Mutual fund will charge you Rs. 40,000/-. This difference of Rs. 13,000 is not only for one year but it continues and increases every year till you hold the fund. This set offs the allocation charges levied in the initial years.
Whether an ULIP is a better option compared to term and mutual fund combination is largely depend on these charges. Buying a ULIP can only be good if you continue to pay the full premium till the end of the term and also opt for maximum cover available in the plan. The reality is, there may be good ULIPs available in the market, which can be competitive compared to term and MF combination, but in the hundreds of plans available in the market, it is very difficult to identify the right one. Secondly agents also do not promote this because of lower commission.
This article first appeared at myiris.com on 26th August'2010
