6 factors to consider before buying ULIPs

Unit linked insurance plan, ULIPs, can safely be termed as modern day 'best-sellers' amongst life insurance products. It is a fact that ULIPS are a seller's product rather than a buyer's product. ULIPS have been the favourites of life insurance agents who have aggressively propagated this product in the recent past and have made them what they are today.

So how does a consumer decide amidst plethora of ULIP plans available in the market? How does s/he come to a decision whether to buy it or not? Should s/he just trust the product which the agent is aggressively trying to sell? Or should s/he do her/his own research and decide for herself/himself? So what should you look in a ULIP product?

Here, we have listed top six parameters for you to consider before you decide to purchase them:

1. Premium allocation charges

This is one parameter you need to be alert about as it could be the main differentiator between a good and a bad ULIP product. These are basically the distribution charges which go in the agent's kitty hence are a root cause of ULIPs being aggressively marketed.

The charges vary to a great extent between plans, with the bulk of the charges charged in the first year, declining in the subsequent years. They lie in a wide range of 0 per cent-100 per cent of your first year's premium with the average being around 25 per cent for first year.

Due to this wide disparity one needs to compare these charges before arriving at a decision.

While comparing these charges one needs to be careful of the language used by insurance companies. Some companies claim to allocate 100 per cent of first year's premium towards guaranteed maturity addition. This is sometimes incorrectly comprehended as 0 per cent allocation charges.

For example: First year's premium = Rs 1,00,000
Tenure = 15 years
First year premium allocated towards 'guaranteed maturity addition' is 130 per cent of first year's premium.

What this essentially means is at the end of 15 years you will get a guaranteed addition of Rs 1,30,000 (130 per cent * 1,00,000). Now discounting this at a modest rate of 6 per cent, we get a present value of Rs 54,244.

In short only Rs 54,244 out of your first year's premium of Rs 1,00,000 were invested. That's the trick. In essence, there is an unstated charge of 45.75 per cent.

Hence, we can see that comparison of these charges is absolutely necessary: be it disclosed charges or unstated charges as in the above example.

The author is vice-president, personal finance, at apnapaisa.com 

Your premium less the premium allocation charge (Rs 1,00,000 minus Rs 45,756) is then invested into various funds offered by insurance companies.

Each fund typically has two components: equity and debt with a cap on the minimum and maximum exposure to the two components.

You need to compare the different fund options and choose the preferred exposure to equities and debt based on your goals and age.

There is also an option of free switching between funds for a specific number of times in a year. The fund options offered under each plan vary from 3 to 9.

This fund value then grows/reduces according to market conditions and performance of the fund.

At the end of every year the balance fund value is then subjected to a fund management charge which varies typically from 0.5 per cent to 2.25 per cent of fund value.

Hence there is a need of comparing these charges and deciding the fund you want to opt for.

But keep in mind that higher the equity component of the fund, higher the probability of growth and thus higher charges owing to specialised fund manager's skills.

ULIPs typically have a minimum term of 5 years with the upper end being 75. It however makes less sense to enter this product with a short-term horizon.

The minimum time that you need to be in ULIPs should ideally be15 years.

This stems from the fact that ULIPs have very high charges in the initial years declining to as low as 1 per cent to 2 per cent in the fourth year onwards leaving a significant amount to grow in the funds.

Hence one needs to compare the term being offered and opt for a term of 15 years or more to make the most of this product. So it is important to go in a for a ULIP product with longer time horizon.

The death benefit is typically:

• Higher of sum assured and fund value
• Fund value + sum assured

However plans with fund value plus sum assured are not necessarily the most beneficial as their premium allocation charges, policy administration charges could be significantly higher as compared to policies offering higher of sum assured or fund value benefit thus bringing down the fund value in the former case.

Hence, it is necessary to compare two plans with different benefits in line with their charges.

In majority of the plans the maturity benefit is the fund value. In some cases you get a guaranteed maturity benefit addition. As explained earlier plans with such options are not necessarily the best buys as it involves high costs in the initial stages.

ULIPS are slightly complicated products so proper understanding of the product is extremely important. Various plans offer different benefits but you need to understand that each benefit comes at a cost.

Now these costs vary across plans and hence a detailed effect of charges on your fund needs to be seen before arriving at a decision. These are the top six parameters you should look at before arriving at a decision. So before buying a ULIP look for answers to all the above questions besides your future needs, your age, your risk taking ability to venture out in equity funds.

Only then will you be able to enjoy the benefit of this product: a mix of insurance and investment. Go ahead and have best of both the worlds so that it does not become a double-edged sword!