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11 reasons why you should not buy ULIPs
I am sick and tired of reading about 'should I buy a ULIP or a MF' kind of articles. I know people who buy both, I know people who do not buy both, I know people who swear by either one. It takes all kinds to make the world does it not?
However, here are some reasons why I am disillusioned with the industry in general. I started off as a great votary for one life insurance company which came out with plans which had AMC charges of 0.8 per cent (dramatically low) for equity funds. I jumped and bought the product. Then they came out with another double benefit plan -- which was unique in its concept of paying an annuity apart from an immediate payment of the death claim. In its original form (as how I bought it) frankly it is a great product if you need life cover and your dependent prefers an annuity because he/she cannot handle investments.
However, as the product grew popular the company added a lot of unnecessary features and dramatically increased the costs. This to me was not very shocking, but unnerved me -- tough to make a 30-year commitment to a client with the constant risk of changes lurking. So here are the reasons why I do not like Unit Linked Policies:
1. The terms can change
This is a complete disaster. Once you have bought a product assuming the AMC charges are 0.8 per cent you believe it will not change. However, some 'Relationship Manager' will show you clause 37 in font size 7 that says charges are subject to change. This can change the value proposition completely. It is like Tata Motors saying "in the 3rd year you will have to pay Rs 1.2 lakhs for servicing the Nano, and servicing is compulsory".
2. Employees enthusiasm to buy
Many life insurance employees are lateral entrants from the mutual fund industry, or people new to the financial services industry. They interact with mutual fund agents and in great gusto start doing SIPs in mutual funds! The enthusiasm with which the employees buy mutual funds is far, far greater than their commitment to ULIPs! Those who have any life insurance have term insurance or nothing. No big employee commitment to UL products is visible. It is not to say that the employee understands the product more or less than the end user, but I find it uncomfortable if an Indica dealer moves around in a Santro or a Maruti 800!
3. Stuck to the fund manager
Sadly if a fund manager leaves, you cannot shift your funds to another unit linked plan. In most life insurance companies the equity corpus is small. This means the economies of scale do not kick in, the services of the registrar is not outsourced (so it gets more expensive) and the life company finds it expensive to hire good fund managers. However, fund managers do quit -- and you have no clue as to how to react to it. It is of course easy to say 'we have a process in place', but look at some of the best performing mutual funds -- Prashant Jain, Madhusudhan Kela, Sukumar -- all have been with the same funds (schemes) for a very long period, and it helps.
4. Large cap bias
One of the main reasons why big mutual funds (like HDFC Top 200) are beating the index is perhaps the way the index is structured. Currently the index is not doing too well because Reliance is under some growth pangs. A fund's out- or under-performance is decided on the basis of a few stocks -- in 2007 it was Bharati and RCom. In 2009, these two shares would have chewed your performance. However, the UL portfolios are very heavily loaded towards the tried and tested heavyweights. Hence, if you get index out-performance, you might end up getting poor absolute performance!
5. Too much of the charges are upfront
If too much money goes into the upfront charges, not enough of your money goes to work immediately. In a way, if you had bought a UL policy in the month of January 2009, your NAV would have gone up, but only on 30 per cent of the premium paid -- the other 70 per cent is lost to charges. However, in 2008 it would have been good -- you may have lost less, but still wiped out your capital!
6. Service
Mutual fund services -- whether it is getting the statement, switch, ease of withdrawal -- are favour the mutual fund industry vis-a-vis the life insurance companies.
7. Construction of the product is too complicated
Understanding an unit linked plan is really difficult. It is like a constant race. The less that the end user understands the greater money the manufacturer and the distributor can make perhaps?
8. Sales force is OBVIOUSLY focused on earnings
A friend who wanted to invest Rs 500,000 was sold four unit linked plans of Rs 125,000 premium each -- a very inefficient way! However, the distributor made far greater money -- about Rs 40,000 more -- than he would have by selling it as one Rs 500,000 plan. This read with clause 7 shows why financial planners who do not sell life insurance plans for a living suggest a simple term plan instead of a complicated UL plan.
9. People who do not understand risk opt for ULIPs
This along with high upfront charges ensures that you will never be able to treat this as an investment. At best it is a savings product -- and a very inefficient one at that.
10. If you already have a unit linked plan find out the IRR (internal rate of return) on that product
Put all the premia paid in an Excel sheet then type the current value (with a -ve sign) -- let us say you have invested Rs10,000 per annum for six years and today it is worth Rs 65,000 (after six years) your IRR would be 2 per cent.
11. It is a rich man's product
Suppose you wish to invest Rs 500,000 a year and wish to invest it in 5-6 funds then you can choose to put Rs100,000 per annum (or Rs 8500 per month) in a ULIP. Why Rs 8500 a month? Simply because the absolute charges (like administration charges etc) at Rs 70 a month can really hurt a policy with a lower premium. A person who wishes to invest only Rs100,000 a year cannot afford a UL of Rs 100,000 pa! So by the time you have enough money to invest in a UL, you may be say 45 years old. At that age you do not have too much time for compounding. Heads I win, tails you lose.