ULIP: a good concept and its mis-selling
ULIPs are insurance policies that pool protection and investment together in a single policy. With a single investment, you get a life cover as well as an avenue to invest your money in the capital markets. Because of this, ULIPs are fraught with a certain element of risk, unlike traditional life insurance policies. In a unit linked plan a portion of the premiums that you pay, goes towards meeting your insurance needs and another towards investment. With the invested amount, units are allocated in a fund of your choice. The funds could be purely equity based, debt or a combination of the two. The value of your investment thus depends on the performance of the underlying fund. It is because of this ULIPs carry a degree of risk in them.
ULIP, as a concept, is a major improvement on ‘traditional or endowment plans’ from insurance companies. This is because the endowment plans are totally opaque. As an investor, you have no idea how much of your premium goes for insurance cover or investment, where the money is invested, how much is the return generated, etc. Though insurance companies declare some ‘annual bonus’ in the middle, it is also useless because investors’ can’t withdraw these bonuses till maturity.
The main advantage of ULIP, on the other hand, is its transparency. All expenses are clearly stated upfront here. These expenses are policy allocation charges, policy admin charges, switching charges, redemption charges, fund management charges, mortality charges, etc. While the fund management charge is considered while computing NAVs, other expenses are taken care of by deducting the number of units you hold. Due to this, the NAV series of ULIP and mutual funds are not comparable. Investors are allowed to switch between equity and debt without any tax incidence in the middle and this is the main advantage of ULIPs.
If ULIP was a good concept, how come it got equated with ‘scam’? It is mostly because of the actions of private insurance companies who launched a series of ULIPs that paid very high commissions, which varied from 60% to 100% of the first year premiums. This upfront commission encouraged its massive mis-selling and was the main reason to convert a good concept into a scam. The arguments put out by insurance CEOs now that paying 60% upfront commission for a 20-year product is equal to 3% p.a. is simply wrong. This is because this calculation doesn’t consider the time value of money.
The Insurance Regulatory and Development Authority (IRDA) woke up to this menace in 2010, but most of the damage was already done. Several investors have already lost money to the ULIP scam and have deserted the insurance altogether. And by this foolish act of sacrificing the customer interest, the private sector insurance companies have lost their golden opportunity to reach out to the masses.
Though the ULIP has become a much better product after the new guidelines, the damage is already done. And due to low commission now, no insurance agent sells them. These agents are now chasing investors with ‘safe’ traditional plans. However, ULIP, where you get the insurance and investment together, was not a bad word earlier. Being a market related instrument, the state of the market has a big impact on the performance of the fund. However, research suggests that not all ULIPs have performed well and have given reasonable returns to the investors.