Why ULIP is not the best insurance product

Selling insurance is considered to be a tough job by some industry insiders. Well not exactly by some hot shot MDRTs. In case you didn't know, MDRT stands for Million Dollar Round Table and this is the most coveted title in the insurance sales industry.

And there's no prize for guessing why insurance policy advisors and agents of all hues sell you those high costing insurance products like the unit linked insurance plan, ULIP.

Now becoming a MDRT does not mean that you have advised your clients in their best interests; it simply means that you have sold more policies and hit targets required to qualify for MDRT.

But most of the agents tout MDRT as if this were any substitute for good advice that they give and some sort of a qualification.

Below I have given two common conversations in the insurance industry to highlight some finer points.

They sell you what you don't want

Mis-selling (Selling insurance products without understanding your needs) is rampant and whether you are a newborn or a 60 year old, insurance will be the first product sold to you.

Selling insurance is a business and you better understand what's under all their sweet talk and projects.

Don't mix insurance with investment. They are two separate decisions having different impacts on your life.

Generally insurance is sold through friends, and family and hence there is a social obligation to buy the policy. So even if you have to honour a social obligation, buy a term plan.

First conversation

Suresh (Agency Manager): We need to hit our targets this year and become the number one branch of our company in terms of lives covered and premiums received.

Ramesh:  I have one client who wants to opt for a term plan.

• SIP or ULIP? Which is better?

Suresh: Boss why don't you offer him our ULIP. He will not be able to exit for the next 7 years (even though we say that he can exit after 3 years). ULIP premiums will get you closer to the MDRT faster, plus there is an additional bonus that you will get for selling this product.  (Also, you can sell him more because even after buying this policy, he will still be underinsured).

Ramesh: Why do you say that he will not be able to exit the policy after 3 years?

Suresh: The 30 per cent costs that go towards covering mortality charges and other expenses while buying ULIPs are charged upfront and considering the state of the market, it would take at least 6-7 years for our product to break even.

Ramesh: I get it now, Sir.

Second conversation

Bank Manager: Why don't you buy our Child Plan. It's a great product and has given 30 per cent return in the last few years.

Client: My financial advisor told me that I could opt for a term plan and a combination of stocks, mutual funds and Public Provident Fund (PPF) investments for my child's better future.

Bank Manager: I will show you some calculations and you can see that this insurance is a long term product and the higher costs that you incur today evens out in the later years whereas mutual funds and stocks are short term offerings. So a term plan and a mutual fund is not a great combination.

ULIP charges: The main culprit

Now let's take a real world example of how you would have fared if you had bought a ULIP in the last 4 years or so.

Cover: Rs 1 Lakh

Premium paying term: 15 years

Premium: Rs 8,592 per annum

Option: Enhancer (35 per cent exposure to equity)

*Cost of insurance here includes the mortality charge, fund management charge, administrative details of Rs 22 per month etc. This figure varies from year to year.

Reality check

If you notice here the charges are deducted from the number of units that you have and not from the NAV. So if the NAV of this fund has increased by 30 per cent it is of no relevance to you as the charges are so steep in the first year that it will just take several years for your investment to break even.

• Get your insurance priority right 

Now let's take stock of your policy value in January 2007:

This is the premium you paid from 2003-2007:  Rs 8,592.00 * 4 = Rs 34,368

Despite a roaring bull market for the last four years, the policy has still not broken even and is down a whopping 21 per cent.

Now let's consider a term plan and an investment in Templeton India Pension Plan which invests around 35 per cent in equity and the rest in debt.

Term plan premium for a cover of Rs 1 lakh: Rs 400

Balance available for investment: Rs 8,592 – Rs 400 = Rs 8,192

Actual amount invested in Templeton India Pension Plan considering an entry load of 1 per cent and expenses of around 2 per cent (That are charged upfront): Rs 8,192 * 0.97 = Rs 7,946.24

Current value of your investments = Rs 50,633.44

This is Rs 50,633.44 – Rs 27,135.88 = Rs 23,497.56. Almost 87 per cent more than if you had opted for the ULIP.

Just think about the compounding effect this can have on your returns and its good enough to debunk the theory of comparing the costs of insurance plans with other investments and saying that costs even out in the long run.

Just because 50,000 fools say so, it does not make ULIP the right product. As you can see ULIPs lag the 'Term + Invest the Rest' theory by a huge margin of 87 per cent even after 4 years of spectacular stock market returns. 

ULIP is not the best insurance product

The reality is that most of the ULIPs take more than 5 years to break even. Policies where the costs are 65 per cent and upwards have not even recovered the principal despite the strongest bull market we have ever witnessed.

• Buying mutual fund units? Do it your way

One of our acquaintances was recently shocked to see Bajaj Allianz charging a 70 per cent cost on his policy. He along with around 30 more employees of a renowned hospital in Mumbai was shocked to see why only 28 per cent of the money was invested.

The best part is that the private bank that sold it to them belonged to the same management as the hospital and hence people are reluctant to take an open stance. Calls to Bajaj Allianz yielded the response 'It is not our responsibility. It is the bank's responsibility'.

This is a very common case where insurance companies often wash their hands off after such bouts of misselling and often look for scapegoats.

At the same time, insurance companies dangle the carrots of paid foreign trips & more money and ensure that the interests of policy buyers are not aligned with the interest of policy sellers. Unless this happens, such stories are bound to be common.

Amar Pandit is a certified financial planner and runs the Mumbai-based firm My Financial Advisor.