Ulips are cheaper, yet not useful

Cost is not the only factor that one should look at. It's best to keep investment and insurance apart

With the stock market going up, unit-linked insurance plans (Ulips) seem to be making a comeback. In recent times, a number of top insurance companies - HDFC Life, Bajaj Allianz and others - have launched online Ulips that are cheaper, as the insurers are able to pass on the savings on agents' commission as lower premium allocation charge and hence, the low-cost proposition. Add to that, the surge in the stock market, and suddenly, we have a heady cocktail of low cost, a good likelihood of a high returns and, of course, tax benefits under Section 80C - a perfect investment product. Yet, it isn't for a number of reasons.

Not a proper investment product
For one, if you are looking at it as a pure investment product, you will be grossly disappointed simply because of the cost. For one, in the offline version, the cost continues to be high. For example, for a five-year policy, the maximum commission that can be paid in the first year is 15 per cent and for a 10-year policy, it is 30 per cent. In addition, five per cent can be paid in the subsequent years for the entire premium-paying term.

But in the online version, this cost is down significantly. Deepak Yohannan, CEO of MyInsuranceClub.com, a web aggregator approved by the Insurance Regulatory and Development Authority (Irda), explains that the gap between mutual funds (MFs) and Ulips have come down, especially with the entry of the online Ulips with charges of 2-2.5 per cent. But there is a small question of mortality charges which go up as you grow older.

Though Irda has capped the difference in gross and net yield at four per cent in the fifth year and three per cent in the tenth year and 2.25 per cent from 15th year onwards, the returns aren't substantial for a market-linked product. Taking the Sensex as a benchmark, which has returned 11.45 per cent annualised in the past five years, a Ulip holder would have earned not less than 7.45 per cent. But it would be lower than any fixed deposit. And we are not even considering the portion that is being deducted due to mortality rates. It's important to look at mortality rates because it is not included in the cost and can drag down returns considerably - especially true for very high sum assured or when older people opt for Ulips.

Besides the mortality, if one looks at the product from a pure returns perspective, things would look something like this. If the Sensex continues to give the same percentage returns for over 10 years, the policyholder would earn not less than 8.45 per cent in the tenth and 9.2 per cent from 15th year onwards. In other words, one will have to stay invested at least for 10 years and above to start getting returns similar to mutual funds with expense ratio of two per cent (large schemes) to three per cent (smaller schemes).

As Amar Pandit, financial planner, points out: "One important negative is the lock-in period. In case of mutual funds, one can exit the scheme if it is a non-performer over a few quarters. In this case, all the costs are front-loaded and one really does not know when returns will be good. And once a policy has been bought, one has to stick around for years even if there is no performance." From a tax perspective, there is no difference as returns from equity mutual funds are tax free after one year. In case of Ulips, there are two ways in which payouts are possible. In the case of death of the policyholder, the amount received by the nominees is totally tax free in their hands. If the policy matures, still there is no tax under Section 10 (10D).

Not a pure insurance product either
From a pure insurance product perspective, it still fails the test. There are enough term plans, which are cheaper for a similar tenure and sum assured. And online ones are even cheaper. For example: A 30-year-old paying a premium of Rs 12,000 annually for 10 years will get a sum assured of Rs 1.2 lakh. In case he buys a term plan of Rs 11,463 annually for 10 years, the sum assured will be a whopping Rs 1.5 crore. The difference: In case of Ulips, he will get some return which can be Rs 1.7 lakh calculated at the rate of 8 per cent. You will get back nothing as survival benefits, in case of a term plan.

Wrong sales pitch
When the market is doing well, agents push these products by showing immediate historical performance of say, one or two years. With the Sensex rising by over 25 per cent the past year, the performance of many existing Ulips would have improved substantially. Anup Rau, CEO, Reliance Life Insurance, says Ulips have caught the attention of people only because the markets have been performing well. "There is a tendency to sell short tenure Ulips and that is detrimental to the customer because they would not get optimum returns," he says.

According to him, nothing much has changed between 2010 when policyholders started moving out of the product and 2014 except market conditions. "The product is sensitive to the Sensex. As a result, when markets are bad people discontinue their renewals and redemptions also go up when markets rise. This is not the way an insurance product should be looked at."

Investment-cum-insurance doesn't work
Financial planner Gaurav Mashruwala says his main reason for not advising Ulips is because of the discomfort in recommending two-in-one products. More importantly, there is no way one can compare Ulips' performance. While there are a number of third-party agencies like Value Research, Morning Star and others who provide daily NAVs and details of products, in case of Ulips there aren't such agencies, which provide comprehensive data. In the absence of such data, choosing becomes more difficult. While insurers do provide a lot of disclosures about their portfolios and net asset values now, but reviewing a Ulip vis-à-vis another is a very difficult process.

Says Pandit: "My job is to de-clutter an investment portfolio. If I see that a Ulip is not performing as well as it should, I would like to exit it. By in the process, I will also lose life insurance. So, having such a complicated product in the portfolio is not the best idea.

Raising money through Ulips is also not a great idea. According to Irda guidelines, the maximum amount that one can be sanctioned against a Ulip is 40 per cent of the net asset value in policies which have more than 60 per cent in equities. In case of policies in which the debt component is 60 per cent, the maximum amount that can be borrowed is 50 per cent. In case of mutual funds, it is slightly higher at 50 per cent.

The comeback of Ulips has to be seen from the context that it was heavily mis-sold in the late 2000s. To go back into the past, unit-linked plans had become a cause of concern for the customer due to the high charges levied by insurance companies, sometimes even more than 110 per cent of the first-year's premium. This led to excessive mis-selling by agents who did not disclose the commission.

This invited regulator Insurance Regulatory and Development Authority (Irda)'s wrath and new guidelines were introduced in 2010. As there was no incentive for distributors, Ulip sales saw a sharp drop. Insurance experts said while overall charges in Ulips have come down since September 2010, other charges - including mortality charges, premium allocation charges - continue to be as high as 35-40 per cent. Though things are much better than the earlier phase, buyers should look at these products from the perspective that they are buying a bundled product, which is undesirable.

History of Ulips

The first unit-linked insurance plan was launched by Unit Trust of India, a mutual fund house, in 1971

Private life insurers entered the insurance sector in 2000

The Insurance Regulatory and Development Authority (Irda) came out with detailed guidelines for Ulips in 2005

Due to higher commissions, many agents sold it aggressively during 2005-2008, when the stock market was rising consistently. Share of Ulips almost went up to 70-80 per cent in companies

In 2008, when the market crashed, customers realised that instead of doubling their money in three years, they were reduced to half or even less due to high front loading

Complaints began to be filed with the regulator, insurance ombudsman and consumer courts on how several investors were duped of crores by clever agents out to make a quick buck

In April 2010, markets regulator Securities and Exchange Board of India (Sebi), under chairman C B Bhave, banned 14 life insurers from raising money without its permission

Sebi-Irda entered into a tussle to control Ulips. The government ended the turf war in June 2010 through an ordinance declaring Ulips will be regulated by Irda

In September 2010, Irda issued stringent guidelines cutting down commissions significantly and increased disclosures and increased the minimum lock-in to five years.

Sales immediately took a big plunge since distributors did not have any incentive to sell. Ulip portfolios of insurers dipped to 20-30 per cent due to increase in redemptions by policyholders as well

In 2013, guidelines for linked products was again modified, reducing the net yields apart from linking commissions to tenure of the product, with higher tenure products giving ability to an agent to earn higher commissions

With stock markets rising, Ulips have started making a comeback, mostly through the online route