(An ultimate guide) to Unit-Linked Insurance Plans (ULIP's)

Unit-linked insurance plans (ULIPs), being the most popular insurance products available in the market, are life insurance products, which provide risk cover for the policyholder along with investment options to invest in any number of qualified investments such as stocks, bonds or mutual funds. This plan helps customers to avail the benefits of both insurances, as well as wealth creation over a long term. ULIPs are linked to the capital market and offer flexibility to invest in various financial instruments according to one’s risk appetite, future needs, etc. This feature of ULIPs makes it popular among those who want to have risk protection as well as investment option inculcated in one product. Why should one buy ULIPs? ULIPs provides a number of advantages to the investors, because of which it is a widely popular product. Some of the advantages of ULIPs are listed below:

Market-linked returns:

ULIPs help the investor to get market linked returns as some portion of the premium paid is invested in funds which further invests them in different market instruments including equities and debt as per your risk appetite. This makes you linked to the market and stands a chance to earn returns based on the market.

Flexibility:

ULIPs offer the investor a wide range of flexible options such as

The option to switch between various funds to match your changing needs. These funds range from aggressive to conservative variants depending on the needs of the investor
The facility to partially withdraw from your fund, subject to charges and conditions.
Single premium additions to enable the policyholder to invest additional sums of money (over and above the regular premium) as and when desired, subject to conditions.
The option to choose the life cover is also available in ULIPs
It also offers the flexibility to avail the benefits of riders by charging an additional amount of premium.

Investment and Life protection:

ULIPs gives you dual benefit of insurance as well as investment. It provides you with a risk cover along with various investment options in which one can invest. It also inculcates the habit of savings and investing both of which are essential for wealth creation.

Liquidity:

ULIP schemes give liquidity to the investors to wholly or partially withdraw their money depending on the terms and conditions of the insurer. Some insurers have a lock-in period of 3 or 5 years after which the investors are free to partially or wholly withdraw the money. If an investor wishes to partially withdraw the money then the there is a limit beyond which he cannot withdraw it. And if he wishes to wholly withdraw the money then in this case surrender charges would be applicable. This facility enables the investor to meet the financial needs at critical stages like children’s education, or for business etc.

Tax Benefits:

Premiums paid by an individual or HUF under this plan are eligible for tax benefits under Section 80C of the Income Tax Act, 1961. Under Section 10 (10D) of the Income Tax Act, 1961, the benefits received from this policy are exempt from tax. However, Section 10 (10 D) benefit is not applicable in case of Single Premium payment.

Transparency:

One can check the ULIP NAVs to keep a check on the returns given by it and stay invested in only return yielding funds. Disadvantages of ULIPs Though ULIPs are one of the most popular insurance products available in the Indian market, still it is not accepted by most of us because of its drawbacks.

Returns are subject to market fluctuations: Returns in ULIPs are market-linked and we all know about the market fluctuations. So they are of no good if you are investing in it for a short term as the market tends to be very volatile in the short term.
Expensive and complex: ULIPs are expensive because the premiums charged for life insurance are higher as compared to term insurance. And they are complex in nature because of the charges levied by the insurers on it.
5 year lock-in period: There is a five-year lock-in period in ULIPs, so you cannot make withdrawals within the five year period.
Higher costs in initial phase: Initially the charges in ULIPs are higher but later on they reduce.

In all ULIPs are suitable for those who are willing to invest in it for a longer term which is at least 10 years and also for those who are not good in managing their financial assets. How do ULIPs work? ULIPs are those where the benefits are expressed in terms of a number of units and unit price. The number of units, which the customer would get, would depend on the unit price when he pays the premium. The value of each unit, at any point in time, is called the Net Asset Value (NAV). When you invest in a ULIP, a portion of your premium is allocated for the insurance cover while the rest is invested in the fund chosen by you. The funds in which the premium gets invested are managed by the fund managers of the insurance company. Charges involved with ULIPs

The charges usually attached to this type of policy are:

Premium allocation charges: This charge is levied to compensate for the expense incurred towards issuing of policy which involves distributor fee and cost of underwriting of funds. These charges are higher in the beginning but tend to reduce after some time.
Administration charges: Administration charges are towards the servicing and maintenance of the policy such as the cost of paperwork, workforce, and other similar expenses. It is charged on a monthly basis.
Fund management charges: This is a charge for the management of the fund and is levied as a percentage of the value of assets. This fee is charged by the insurance companies before arriving at the net asset value.
Fund switching charges: ULIPs provide flexibility to choose fund option as well as switch between them in case you want. A fee for switching is charged for switching your fund type.
Surrender charges: A surrender charge is levied in case of premature full or partial withdrawal of units.
Discontinuation charge: In case you want to withdraw your money from the ULIP within the lock-in period of 3 or 5 years, then the insurer would deduct a small fee. These charges are set by IRDA.
Mortality charges: Mortality charge is generally charged on a monthly basis and is for compensating the insurance company in case a policyholder does not live to the assumed age. These charges differ according to the lifestyle and age of policyholders.
Service Tax Deductions: Before allotment of the units the applicable service tax is deducted from the risk portion of the premium.

Death Benefits and Maturity Benefits Death Benefits: In case of death of the policyholder within the term of the policy then the death benefit will be higher of the Fund Value or Sum Assured, net of partial withdrawals. However, the death benefit also depends on the type of ULIP taken by the policyholder. Maturity benefit: At the end of your policy term i.e. at maturity, you will receive your Fund Value. Therefore the maturity benefit is equal to the amount of fund value.

TYPES OF FUNDS THAT ULIPs OFFER ULIPs offer a variety of funds to suit one’s requirement of risk-taking capacity, investment objectives and the term for which one can stay invested. The returns generated by these funds differ from each other. The different types of funds offered by ULIPs are:

Equity funds: equity funds are invested primarily in company’s stock with the aim of capital appreciation. The risk of equity funds ranges from medium to high.
Balanced funds: Balanced funds combine equity and fixed income instruments. These funds maintain a balance of stock and bond options, resulting in guaranteed returns, with the bonds offsetting the potential risks of equity investments. These funds are categorized as medium-risk.
Cash funds: Cash funds are also known as money market funds. The money in these funds is invested in money market instruments, cash, and bank deposits. The risk involved with this fund is the least but at the same time, the return generated from this fund is low.
Income, Fixed Interest and Bond funds: These funds are invested in corporate bonds, government securities, and other fixed-income instruments. This risk involved with this fund is medium.

TYPES OF UNIT-LINKED INSURANCE PLANS ULIPs can be classified into various categories depending on various parameters Classification on the basis of funds that ULIPs invests in:

Equity funds: The premium invested in ULIPs are majorly invested in equities in the equity fund. This is suitable for aggressive investors who are risk takers.
Debt funds: The premium invested in ULIPs are majorly invested in debt in the debt fund. This is suitable for conservative investors who are risk-averse.
Balanced funds: This fund tries to strike a balance by investing partly in equity and partly in debt. This fund tries to minimise the risk and enhance the returns for the customers.

Classification on the basis of end use of the fund

ULIPs for retirement planning: This plan is suitable for those who want to have a secure financial position at the time of retirement by paying premiums for a specific period of time.
ULIPs for child’s education: This ULIP provides money for child’s education when needed in the form of small chunks of payment by the insurer. One has to pay premiums for a specific period of time for this. This is also a suitable ULIP to secure the child’s education in case of an unforeseen event.
ULIPs for wealth creation: This is suitable for those who want to have a corpus at a particular period of time by regularly investing premiums in the ULIP.
ULIPs for medical benefits: These ULIPs helps by giving financial assistance at the time of medical emergencies to the customer.

Classification on the basis of death benefit

Type I ULIP: In case of death of the policyholder, the nominees will get the death benefit which is equal to higher of the sum assured or fund value by the insurance company.

E.g. Mr X has a Type I ULIP with a sum assured of ₹10, 00,000 and the premium for this policy is paid for 7 years, and let’s say the fund value grows out to become ₹5 lakhs after 7 years. So in the event of a death of the policyholder, the nominees would get the death benefit which is equal to higher the sum assured(₹10 lakhs) or the fund value(₹5 lakhs) by the insurance company. Therefore the nominees will get ₹10 lakhs.

Type II ULIP: In case of Type II ULIP, if the policyholder dies then the nominees will get the death benefit equal to sum assured plus the fund value. The premium of Type II ULIP policy is higher than that of Type I ULIP policy.

Taking the above e.g., in case of death of the policyholder, the nominees would get ₹15 lakhs (sum assured+fund value=₹10 lakhs+₹5 lakhs) ULIP Riders The riders which are available with ULIPs are as follows: