In the previous article, ULIP in India: A Good Concept or SCAM? (Part 1), we all understood how ULIP & various other traditional insurance plans became popular in India. Which directed us towards a question “What’s wrong with ULIP?” or “If ULIP was a good concept, how come it got equated with ‘scam’?”
Let us together find the answer to the above questions.
Insurance in ULIP
If you buy ULIPs to get yourself adequate risk cover or insurance, then you could end up using all or most of your annual income. Please understand the word ‘Life insurance’ means “lump sum money that your dependent family (Not you) will receive if you die.”
Thumb rule says, an earning person should be insured for at least 10 years income + liabilities. However, life insurance cover in ULIPs is 7 to 10 times the annual premium, which is the minimum requirement as per IRDAI. Therefore, to get life insurance equal to 10X of your annual income, you will have to do away with all your income as a premium.
The maths is clear:
|Insurance Required: 10 times of Annual Income|
|Insurance Cover in ULIP: 10 times of Premium|
|If you choose ULIP for Insurance cover: Annual Income = Premium Payout|
Most of us also fail to realise what amount of insurance cover is required, For instance, a family of five members with a sole earning member having an insurance cover of 20 Lakh will surely be not enough in the event of untimely death.
Family life will be even difficult if you have not left enough inheritance & wealth or you have a big loan. On the other hand, inflation will also eliminate all the wealth in the long run. Calculate your Life insurance requirement on Finbingo today!
Let’s understand the above case with an example: Suppose your post-tax, salary income is ₹10 lakh in the current year. Then as per thumb rule, you should have a life cover of at least ₹1 crore. The premium for the ₹1 crore will be:
|Term Life||₹7,000 or more|
(Insurance premium at the time of purchase as per age)
The insurance regulator has mandated 10 times of annual premium as the minimum life cover that ULIPs must provide. However, in the actual products that are pushed by agents, the insurance company only offers this minimum. Insurance companies are allowed to offer 15 times or 30 times life cover as well.
Investment in ULIP
An insurance salesperson will tell you that ULIP also has investment bundled with insurance. While that is perfectly true as per definition, but while investing we must see all products from a practical point of view. Any investment which we consider must be evaluated on the following parameters such as liquidity, capital safety, transparency, lockin period, risk, an option to STOP or PAUSE investment & most important your investment period. Even your risk capacity, tolerance & appetite will be different from your friends or other extended family members.
Let compare each parameter for ULIP
|Liquidity||Lacks the ability to convert investment in liquid cash. All investments in ULIP are locked-in for 5 years from the policy start date. No Withdrawals are allowed.|
|Capital safety||All premiums paid in ULIP are subjected to market risk & not guaranteed.|
|Transparency||ULIP was launched to increase transparency, but even today various T/C & charges are hidden in small print or not informed at the time of purchase|
|Option to stop or pause||
Unlike mutual funds, in ULIP it is mandatory to pay all the premium, otherwise, heavy penalties are applied. Premium payment can not be stopped or paused if an individual is going through a bad financial year.
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|Investment horizon||Most ULIP plans come with a maturity period of more than 10 years (with an option to exit after 5 years) But what if your investment horizon is less than 5 years.|
|Regular Income||In ULIP there is a limited option where any investor could get regular monthly income, which again blocks your fund|
ULIP allows an investor to have their asset allocation based on their risk appetite & also enables them to switch among various asset classes if requested, but one must be careful of charges applied.
Check your ideal asset allocation on Finbingo Wealth Builder
|Cost||Cost of investing in ULIP is very high. We will see each charge in detail later in the article.|
Agent commission in ULIP – Did you know?
All insurance products (including ULIP) have agency cost build-in which is part of instalment payout or premiums you pay. Your agents’ commission is hidden under the banner Premium allocation charges, which is a recurring charge, which means the commission is deducted from every premium you pay. Usually, charges are highest in the first and second years and are constant for the remaining policy term.
How high would you expect an agent’s commission could be in the first year?
Get prepared to be shocked – 5 to 25%.
ULIPs & traditional plans can have up to 25% as agent’s commission in the first year. If you paid ₹1 Lakh as premium a good amount of at least ₹5 thousand is going as commission.
High commissions are a major reason why most of your banks or agents or distributors were interested in pushing traditional plans or ULIPs rather than mutual funds. It is worth noticing out here that almost what gets sold as insurance in India is a form of investment. Term insurance which is pure insurance is barely recommended. This upfront commission encourages massive mis-selling of these insurance cum investment plans and a reason to convert a good concept into a scam.
This commission has drastically come down after the launch of New age ULIPs or 4G ULIP & intervention of insurance regulator (IRDAI) post-2010.
Cost of investing – Charges?
One of the biggest factors which go against ULIP is very high charges. A large portion of the premium you pay in the initial years goes towards various charges. This results in reducing the amount of your premium that is invested to generate returns. These charges make a much larger impact on wealth creation in the long run.
Let’s take a look on a ULIP plan for an individual having an age of 30 pay a premium of ₹50000 for a Sum assured of ₹500000
Below take will show the charges levied by insurance companies & you can verify these charges in your policy papers or offer document. These charges are never hidden, just buried under fine print on which we probably won’t give much importance. The actual investment amount is after deducting all the charges which range from 5 to 7% of the total premium amount.
Considering below charges
|Premium allocation charges||1% per annum|
|Fund management charges||1.35% per annum|
|Policy Admin charges||₹1200 per annum|
|Mortality charges||1.06% per annum|
Only the above charges reflect 5.81% expenses per annum. So, in 10 years you have paid ₹5 lakh. However, the actual invested amount, after deducting all the above charges, will be around ₹4.7 lakh. Expense ratio in direct mutual funds starts from as low as 0.10% per annum, reflecting in high savings by reduction in cost.
Above charges are just for illustration. Fees & charges vary for each insurance-based investment plan based on an individual’s lifestyle & age & insurance company risk assessment.
It’s always better to keep insurance & investment separate. If you have any financial dependents the first thing you much consider is to buy a term insurance plan based on your living standards with optimal risk cover & create an emergency fund. Then park the rest of the money in good diversified two to three mutual funds based on your life goals, risk appetite & investment horizon. We also suggest exploring (our old friend) Public Provident Fund if you are risk-averse, which will even provide better inflation-adjusted returns than traditional insurance plans. A Term Plan with pure investment products such as Mutual Funds or PPF is the best strategy for most investors.
Let’s examine the above scenarios for 10 years
|Alternatives||ULIP||Term Insurance +
|Term Insurance + PPF|
|Plans considered||ICICI Pru Signature plan Bluechip plan||ICICI iProtect plan + ICICI ELSS MF||ICICI iProtect plan + PPF|
|Lock-in period||5 Years||3 Years||15 Years|
|Insurance||₹5 Lakh||₹50 Lakh||₹50 Lakh|
|Return (%)||6.96%||9.08%||8.8% to 7.1%|
Data as on 30th September 2020. For parity, we have considered the ICICI group products from each category providing similar benefits.
In the table above, possible alternatives are – investing in a ULIP or buying a term plan & tax-saving equity mutual fund combo or buying a term plan & PPF combination. The table shows the kind of returns & insurance cover you would get on each alternative if you stayed invested in the last 10 years (based on historical performance data).
The table above explains, in the second option, you get insurance coverage that is ten times than that of a ULIP. Secondly, the return is significantly better in ELSS. This makes it very simple for an investor to make a choice.
An investor should never mix insurance and investment. Insurance is an expense & it should be treated as an expense only, mixing both the will give less of both, inadequate risk cover & moderate returns.