What is ULIP?
A Unit Linked Insurance Plan (ULIP) is a financial product, which, unlike a pure insurance policy, provides both insurance and investment in a single plan. ULIPs are offered by insurance companies. There are multiple variations available, which can be tailored to the customer’s requirements, age and risk appetite.
How does it function?
As mentioned earlier, a ULIP is a combination of insurance and investment. A part of the premium paid is used to provide insurance cover to the policyholder and the remaining is used to invest in debt and equity instruments. In this case, the utilization of money (for investment in debt and equity) from the pool of premiums is like that of mutual funds. The similarities do not end here. Like mutual funds, a ULIP has several units allocated to it, and the concept of Net Asset Value (NAV), used in mutual funds, is applicable here too. Based on the investment needs and risk-taking capability of the individual customer, he/she can customize the fund allocation in ULIP. The funds in ULIP are managed by a group of investment managers, who take decisions on investment and switching of funds.
ULIPs in India
Unit Trust of India (UTI) launched the first ULIP in India, as early as in 1971. The second one came from LIC MF in 1989. Detailed guidelines were issued in 2005 by the Insurance Regulatory and Development Authority of India (IRDAI). All the ULIP schemes are regulated by the IRDAI in India. After the opening of insurance sector in India, many insurance companies have started their own ULIP plans to attract customers towards this unique insurance cum investment product. Customers have a wide array of products to choose from, so that they can make an informed decision on which ULIP to invest in.
Pros of investing in ULIPs
ULIPs are unique in the way that they offer insurance and investment under a single plan.
Using the switching option, you can reorganise your portfolio according to your changed risk perception or market variations. This way, you can protect your capital and possibly increase your earnings.
Apart from switching, you can also invest additional money along with your regular premium in ULIPs. This feature is called ‘top-up’.
Upon demise of the policyholder, the twin benefit of the sum assured, and the investment corpus will be payable to the nominee.
ULIPs are usually used to attain certain financial goals, over a longer time period. Examples include buying a new car/house, child’s education, etc. ULIPs will help you realise these goals, all the while providing you the added benefit of insurance coverage.
There’s a common advice that says, “Never combine investment and insurance.” There is some truth to this. Products which combine these two tend to lock up your money for long periods (five years, in case of ULIPs) and the returns on investment are not on par with other options. So, go for ULIPs only if your investment horizon is long.
Related to the above point, it is better to keep insurance separated and insulated from investment. Term insurance plans provide a much higher cover for a much lower premium, with minimum charges. These can fill up the insurance requirement in your financial planning.
Since a part of premium is invariably invested in the market, the risk of erosion of investment is always present. One needs to evaluate the risk involved before investing in ULIPs. There is a risk of losing out on your investment, rather than earning a profit on it.
Due to the presence of more efficient investment products, ULIPs have lost their sheen now. NPS, ELSS and mutual funds offer competitive returns, and some of them offer better liquidity compared to ULIPs. The transaction and maintenance charges are much lower and with lower risk.
Unlike mutual funds, you cannot stop or pause your investment (premiums) midway. The plan will lapse if you do so.
Section 80 C of the Indian Income Tax Act exempts investments in ULIPs up to a maximum of Rs. 1.50 lacs. In addition to this exemption, the pay-out you receive at the end of term of the ULIP is exempt as well under Section 10 of the same Act. So, if you are looking to save tax and are unable to invest in other tax-saving instruments for some reason, you can explore investing your funds in ULIPs.
Should it be a part of your investment basket?
As mentioned before, the negatives outweigh the positives in the case of ULIPs. There are much better investment avenues available in the market for your hard-earned money. Unless you are left with no choice, it is better to give ULIPs a miss and explore other options, which are more liquid and offer competitive returns. If you have surplus money to spare, and do not mind the five-year lock-in period, you can consider ULIPs as an investment option.