Unit Linked Insurance Plans (ULIPs) have never been a good 'investment' product. We have said that over and over again, and there are valid reasons for saying that.
The reasons
1. The charges are exorbitant and payable upfront in the first 3 years’ of the policy
2. The 3-year lock-in may appear small compared to traditional insurance policies which run up to 15-20 years, but that’s not the right comparison. ULIPs should be compared to MFs, where the open-ended schemes have no lock-in
3. The flexibility is low. You can exit after 3 years, but you may be forced to stay with the ULIP because of paying the hefty charges initially.
4. You are dependent on the performance of just one fund. Instead, you could buy 4-6 MFs with the same money which you pay as premium and build a diversified portfolio and spread your risk.
Why does it sell?
There are many drawbacks but they are still selling, you might say. Insurance companies sell millions of ULIPs because of the following:
1. Belief in safety of insurance products. Unlike traditional policies, ULIPs are investing in the 'risky' equity markets.
2. The unexpectedly high returns from equity in last 2 to 3 years enabled ULIPs to show profit despite the high charges.
With the markets crashing, high returns have evaporated. So, now the reality is dawning on policy holders as they are sitting on huge losses. Besides, the loss in the market, the loss of thousands of rupees in the form of heavy charges is the worrying bit.
Should I close the policy?
The cost-structure in ULIPs varies significantly, not only across different insurance companies, but also across different ULIPs from the same insurance company.
So, each policyholder will have to work out the final exit/retain strategy based on his/her specific policy terms. However, there are three factors to be considered:
— Performance
— Entry Charges or allocation charges
— Annual Costs or fund management charges
The focus, here, is on equity-based ULIPs. And, the basic idea is to check whether it is better to continue paying premiums or instead start investing in MFs.
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Case 1: You have paid first 3 years' premium
Scenario 1: Fund’s performance has been good in the first 3 years and:
1. Both entry and annual fund management charge are lower as compared to MFs
You can continue investing in ULIPs for say 8-10 years till the lower charges in later years offset the high initial charges already paid.
Note: In many ULIPs after 3 years the entry charges (or allocation charge as they are also called) are lower than the 2.25 per cent entry load in MFs (assuming you are investing through a distributor) and the annual charges are also lower than the MFs.
2. Entry charges are higher, but annual charges are lower
You can stop paying further premiums but continue with the policy for say 8-10 years based on premiums already paid. This will help offset the high initial charges.
Now that MFs have no entry load on direct investments, this option may be applicable in most cases.
3. Annual fund management charges are higher
Exit the policy as it may not be prudent to pay high charges on recurrent basis.
Scenario 2: Fund performance has been bad.
You may close the policy and invest in MFs. Early closure will cause a heavy loss, but it is a price worth paying rather than continuing with a bad product. You may finally end-up making better returns in a good mix of funds.
Case 2: You have not yet paid the first 3 years’ premium
Insurance laws stipulate that if the policy premiums are not paid for at least 3 years, the surrender value will be zero. So, one or two premiums paid so far will be a complete loss.
Hence, now the choice is between
(a) whether to forgo the premiums paid till date or
(b) pay up to 3 premiums and then take a decision.
Analyse assuming you have paid 3 premiums and see how it looks. If the decision was to exit, then it may be better to forgo the premiums as a total loss. However, if the decision was to stay, then go ahead and pay at least the 3 premiums. However, in most ULIPs, it may work out that paying at least 3 premiums is a better option.
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