Unit-linked insurance: All charged up What are ULIPs?

A unit linked insurance policy is one in which the customer is provided with a life insurance cover and the premium paid is invested in either debt or equity products or a combination of the two. In other words, it enables the buyer to secure some protection for his family in the event of his untimely death and at the same time provides him an opportunity to earn a return on his premium paid. In the event of the insured person's untimely death, his nominees would normally receive an amount that is the higher of the sum assured (insurance cover) or the value of the units (investments).However, there are some schemes in which the policyholder receives the sum assured plus the value of the investments. Every insurance company has four to five ULIPs with varying investment options, charges and conditions for withdrawals and surrender. Moreover, schemes have been tailored to suit different customer profiles and, in that sense, offer a great deal of choice. The advantage of ULIP is that since the investments are made for long periods, the chances of earning a decent return are high. Just as in the case of mutual funds, buyers who are risk averse can buy into debt schemes while those who have an appetite for risk can opt for balanced or equity schemes. However, the charges paid in these schemes in terms of the entry load, administrative fees, underwriting fees, buying and selling charges and asset management charges are

fairly high and vary from insurer to insurer in the quantum as also in the manner in which they are charged. Tax benefits The premiums paid for ULIPs are eligible for tax rebates under section 80 which allows a a maximum of Rs. 1,00,000 premiums paid for taxable income below Rs 8,50,000 and Proceeds from ULIPs are tax-free under section 10(10D) unlike those from a mutual fund which attract short term capital gains tax. Key features Premiums paid can be single, regular or variable. The payment period too can be regular or variable. The risk cover (insurance cover) can be increased or decreased.As in all insurance policies, the risk charge (mortality rate) varies with age. However, for an individual the risk charge is always based on the age of the policyholder in the year of commencement of the policy. These charges are normally deducted on a monthly basis from the unit value. For instance, if there is an increase in the value of units due to market conditions, the sum at risk (sum assured less the value of investments) reduces and so the risk charges are lower. The maturity benefit is not typically a fixed amount and the maturity period can be advanced (early withdrawal) or extended. Investments can be made in gilt funds (government securities), balanced funds (part debt, part equity), money-market funds; growth funds (equities) or bonds (corporate bonds).

The policyholder can switch between schemes (for instance, balanced to debt or gilt to equity). The investment risk is transferred to the policyholder.The maturity benefit is the net asset value of the units. The value would be high or low depending on the market conditions during the period of the policy and the performance of the fund manager. Thus there is no capital protection on maturity unless the scheme specially provides for it. There could be policies that allow the policyholder to remain invested beyond the maturity period in the event of the maturity value not being satisfactory. What you MUST ask your agent First-year charges: Usually, a minimum of 15 per cent. However, high premiums attract lower charges and vice versa. Charges can be as high as 70 per cent if the scheme affords a lot of flexibility. Subsequent charges: Usually lower than first-year charges. However, some insurers charge higher fees in the initial years and lower them significantly in the subsequent years. Administration charges: This ranges between Rs 15 per month to Rs 60 per month and is levied by cancellation of units and also depends on the nature of the scheme. Risk charges: The charges are broadly comparable across insurers. Asset management fees: Fund management charges vary from 0.6 per cent to 0.75 per cent for a money market fund, and around 1.5 per cent for an equity-oriented scheme. Fund management expenses and the brokerage are built into the daily net asset value.

Switching charges: Some insurers allow four free switches in every year but link it to a minimum amount. Others allow just one free switch in each year and charge Rs 100 for every subsequent switch. Some insurers don't charge anything. Top-ups: Usually attracts 1 per cent of the top-up amount. Top-up normally goes directly into your investment account (units) unless you specifically ask for an increase in the risk cover. Surrender value of units: Insurers levy certain charges if the policy is surrendered prematurely. This levy varies between insurers and could be around 75 per cent in the first year, 60 per cent in the second year, 40 per cent in the third year and nil after the fourth year. Fund performance: You could check out the performance of similar schemes (balanced with balanced; equity with equity) across insurance companies. Look at NAV performance over a period of at least two to three years. This can only give you some indication about the credibility of the fund manager because past performance is no guarantee to future returns, especially in insurance products where the emphasis is on long-term performance (10 years or more). Since insurance is a product, which entails a long-term commitment on the part of the insurer, it is important not to go only by the features or the cost advantages of schemes but by the parentage of the insurer as well.

Comparing schemes based on costs is a fairly complex exercise. As a rule, the higher the initial years' expenses the longer it takes for the policy to outperform its peers with low initial years' costs and slightly higher subsequent year expenses. Retire unhurt Pension plans are essentially tailored to meet old age financial requirements. But there are certain advantages in joining a pension plan. First of all, contribution to pension funds upto Rs 10,000 is eligible for tax deduction under section 80CCC. In other words, your pension contribution will get deducted from your taxable income. So if you are in the top tax bracket, liable to pay to a 30.6 per cent tax, then your tax savings will be that much. All life insurance companies offer pension products - both conventional and unit-linked. In both cases you pay a certain premium amount for a specified length of time. Usually, the minimum entry age is 18 years and the maximum age is 60 years. You can choose to pay the premium for five to 30 years. When the policy matures, you receive one-third of the value of the accumulated amount as a lump-sum payment. For the remaining, you can buy annuities either from the existing insurer or any other insurer.

While in a conventional scheme, your money is managed through the insurer's pooled investment account and you are entitled to bonuses every year, in a ULIP you receive the value of the investment in your individual account. In a ULIP you have the flexibility to choose between a conservative scheme or an aggressive scheme with high allocation to equities. Pension policy imposes huge penalties for early termination. Most pension plans provides for four annuity options - (1) annuity for life, (2) annuity payable for a chosen term and for life thereafter, (3) annuity for life with return of purchase price on death to the beneficiary and (4) annuity for life to you and then to your spouse with return of purchase price to the beneficiary on death of last survivor - which can be exercised at any time within six months of the vesting date or the date on which you are eligible for pension. Schemes allow postponements of vesting age and also early retirement. How does ULIP work? Sara is a thirty-year old who wants a product that will give him market-linked returns as well as a life cover. He wants to invest Rs 50,000 a year for 10 years in an equity-based scheme. Based on this premium, the sum assured works out to Rs 532,000, the exact amount of premium being Rs 50,032. Based on the current NAV of the plan that Sara chooses to invest in, he is allotted units in the scheme. Then, units equivalent to the charges are deducted from his portfolio.

The charges in the first year include a 14 per cent sales charge, an administration charge (7 per cent for the first Rs 20,000 and 3 per cent for the remaining Rs 30,000) and underwriting charges, which are deducted monthly. Besides, mortality charges or the charges for the life cover are also deducted. For the remaining nine years a 3.5 per cent sales charge and an administrative charge of 4 per cent (for the first Rs 20,000 and 2 per cent for the remaining Rs 30,000) are levied in addition to mortality charges. Fund management fee of 1.5 per cent (equity) and brokerage are also charged. This cost is built into the calculation of net asset value. On maturity - that is, after 10 years - Sara would receive the sum assured of Rs 532,000 or the market value of the units whichever is higher. Assuming the growth rate in the market value of the units to be 6 per cent per annum Sara would receive Rs 581,500; assuming the growth rate in the market value of the units to be 10 per cent, Sara would receive Rs 7,24,400. In case of Sara's untimely death at the end of the ninth year, his beneficiaries would receive the sum assured of Rs 532,000 or the market value of the units whichever is higher. Assuming the growth rate in the market value of units is 6 per cent per annum, the value of investment would be Rs 510,200. However, his family will get Rs 532,000 as it is the sum assured.

Assuming a growth rate of 10 per cent per annum, the value of units at the end of the ninth year would be Rs 621,900. Hence, the beneficiaries would get Rs 621,900. Unit-linked insurance plans — The honey and the sting

THE equity market, when it is all abuzz, has the magical quality of morphing into a honeycomb. Investors swarm it, lured by the prospect of high returns. It is no different now. Investors — those that deployed funds directly or through the mutual funds route — have had a rich harvest of honey. Another class of investors that has reason to smile is the one that invested in equity-oriented schemes of unit-linked insurance plans. These plans enable investors track the performance of their net asset values everyday. With companies having unit-linked products wasting no time to broadcast accomplishments, the advertising business is also abuzz. While mentions in business dailies are par for the course, it is not uncommon to see hoardings announcing the spectacular returns that such plans have delivered.

The temptation to get carried away by the hype can be irresistible, but now is the time to exercise some discretion. A look at how suitable the unit-linked plans are from an insurance perspective, and what factors investors need to consider. High returns and sustainability The high-decibel advertising campaigns may lead investors to believe that the returns generated over the past few months are sustainable. Nothing could be farther from the truth. To draw a parallel, similar advertisements were put out by mutual funds during the heady days of the market in the mid-1990s. For instance, campaigns with such punchlines as "100 per cent return in 10 months" were common. Investors who entered such funds were left high and dry when the market tanked. Suitability of options Unit-linked insurance plans usually offer three schemes: One oriented towards debt and money-market instruments, another with a tilt towards equities, and a third that seeks to achieve a mix of investing in both equities and debt. If one opts for the plan that invests primarily in equity, the buzzing market could lead to windfall returns. However, should the buzz die down, investors could be left stung. If one invests in a unit-linked pension plan early on, say 25, one can afford to take the risk associated with equities, at least in the plan's initial stages. However, as approaches retirement the quantum of returns should be subordinated to capital preservation. At this stage, investing in a plan that has an equity tilt may not be a good idea.

Fund management style Considering that unit-linked plans are relatively new launches, their short history does not permit an assessment of how they will perform in different phases of the stock market. Even if one views insurance as a long-term commitment, investments based on performance over such a short time span may not be appropriate. What has happened over the past few months is that such plans have participated in the broad-based rally in the market to deliver high returns. However, these returns are certainly not an index of what investors can expect in the future.

For instance, mutual funds posted spectacular returns in the mid-1990s and their net asset values (NAVs) zoomed. When the buzz died down, the erosion in value was equally swift. Quite a few funds have managed to recover from their battered NAV levels. Bluechip and Prima, now from the Franklin Templeton stable and then part of Kothari Pioneer, have recovered considerably to post annual returns of 25 per cent and 20 per cent respectively over a 10-year period. And this has been achieved on an asset base that has swelled considerably, especially over the past couple of years.

This ability to handle business downturns, maintain performance on an increasing asset base, and emerge unscathed is a reflection of the quality of fund management. And the same yardstick should be applied to evaluate insurance companies as well. Current evidence is inadequate to pass judgment on how they will stack up when the going gets tough. Till such time they prove that they can deliver the goods under tough market conditions, investors will be better off opting for plans that invest primarily in debt, which have lower downside risk. Market timing To maximise returns even during such bullish phases, it is imperative that investors time their entry and exit from the markets. As far as stocks go, returns tend to be compressed over a short timeframe. (To illustrate, the Sensex has put on 60 per cent in a span of six months this year.) Staying put too long in a unit-linked insurance plan that focusses on equity may deplete returns if market mood turns negative. This implies that investors should deftly switch between schemes within a plan to get the biggest bang for their buck. For instance, investors who want to lock in to the gains on the equity portfolio can switch whole or part of their exposure to the debt-oriented plan. Charges aplenty Various charges are levied on such plans. They either lead to a deduction from the investment amount that is brought in or are adjusted by liquidation of units. In both cases,

returns are affected. Typically, charges are high in the initial two years before they taper off and stabilise for the rest of the plan's term. This would mean that the effective amount available in the first two years would be 80 per cent of what has been invested. Thereafter the investible surplus is higher. In the current bull run, the high returns mask the charges levied. But if returns drop to single-digit levels, investors will feel the pinch. One also needs to consider the deduction that will be made if one opts for life cover. If it happens to be on a one-year renewal basis, a higher amount will be deducted as mortality charges. This is in contrast to what one pays in a pure term plan under which premiums are fixed on the basis of the mortality risk at the time of purchasing the plan. Course of action PROVIDING life cover is the most important function of insurance; providing returns is just an added advantage of such plans, which gets magnified, given the tax rebates. Investors can consider the following options: Steer clear of opting for life cover under the unit-linked plans; settle for a pure term plan instead, which will offer you a high amount of cover for a relatively lower premium outgo. Investors can look at the debt-based plans as the tax breaks could magnify returns.

Over the long-term they could offer superior returns compared to debt funds offered by mutual fund houses, assuming that the tax breaks are in place. For those who seek a partial exposure to equity in their portfolio, a combination of a pure term policy and an investment in mutual fund schemes, such as Prima, Bluechip, HDFC Equity, HDFC Tax Saver, and Templeton India Growth Fund, is a superior option to the unit-linked plans with an equity tilt. Investors with surpluses and looking at tax-break-oriented investments can consider the equity option in unit-linked plans, despite the risk of a short track record. Balanced funds as a class have not performed well in the Indian context, with only two schemes ( HDFC Prudence and US-95) having a good long-term track record. In this backdrop, the balanced fund option need not be considered. Employing conservative investment strategies in a buzzing market may appear boring. However, when the markets start tanking, such strategies ensure that you are not taken to the cleaners. MUMBAI: Insurance policy holders who have chosen to take the stock market route to protect their life have begun feeling the heat of the falling sensex. Net asset values (NAVs) of most equity oriented insurance policies (ULIPs) have fallen between 10-26%, since the sensex touched a record high of May 11. Unlike conventional insurance policies, ULIP schemes are life assurance policies where proceeds are linked to units in an investment fund, which is invested in debt or equity instruments.

In these schemes, the insured party also has the option to choose the exposure he wants in equity or debt. In the last few months, biting into the stock market euphoria, many retail investors chose ULIPs as their insurance vehicle despite risks associated with stocks. Obviously, schemes with a higher equity component would have fallen more than those with higher debt exposure. Schemes like the Om Kotak Aggressive has seen a 26% drop in NAVs between May 10 and June 7. Similarly, Bajaj Allianz's Unit Gain Equity Plus, Premium Equity Gain have seen a 25.7% and 25.6% fall in NAVs in the same period, respectively.

SBI Life's Horizon Equity has seen a 23.7% reduction in NAVs. Surprisingly, despite this fall, insurance companies claim there have been no redemptions.

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