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Adam Smith said, "All money is a matter of belief." He could have said the same for Ulips, which for some people is insurance, while for some it is investment. The debate never seems to end.
Ulips might have caught your fancy for all the noise around them over the past few years. These are hybrid products that mix life insurance and investments. Like any other life insurance product, these offer life cover along with investment. However, it is left to the policyholder to make the investment choice from the available fund option, thereby transferring the risk of investment to the policyholder. Though, these policies can be more profitable than a traditional insurance policy; it also has a higher risk.
Investment Objective and Risks
The main objective of these policies is to combine risk cover and investments. The choice of fund options available can be used as per one's risk profile to make the most of investments with a fixed insurance cover.
Capital Protection
The sum assured in a life insurance policy is guaranteed as per the terms of the policy as long as the premiums are paid and the policy is in force.
Inflation Protection
Life insurance is not inflation protected because insurance is a fixed cover-fixed tenure product, wherein the sum assured is fixed. However, the equity fund option has all the potential to beat inflation and create wealth over the long-term. But it does not guarantee inflation beating returns.
Guarantees
The sum assured is guaranteed and the premium is fixed for the tenure of the policy. There are a few with profit policies that guarantee a minimum return, which varies across insurers and policies.
Liquidity
Ulips are liquid only after the lock-in period of five years. This is achieved by redeeming units in which the premiums are invested in. One can also make premature withdrawal or surrender the policy at a loss.
• Loans are available against the policy depending on the policy type, the years it has been in force, its sum assured or the fund value at the time of seeking loan.
• The maximum loan amount that can be approved by insurers shall not exceed 40% of the net asset value in case the Ulip fund is predominantly equity-oriented.
• The maximum loan amount that can be approved by insurers shall not exceed 50% of the net asset value in case the Ulip fund is predominantly debt-oriented.
Credit Rating
Life insurance policies do not have any credit ratings.
Exit Option
One can surrender or terminate the policy at a financial loss.
• The proceeds of the discontinued policy for the purpose of refund to the policyholder shall mean the fund value on the date of discontinuance plus interest computed at a minimum rate of 3.5 per cent per annum.
Other Risks
The risk of premiums going down after you have bought a policy exists and so does the risk of premiums going up. There is also the risk of new policies emerging that suit your financial requirements better.
Tax Implications
Premiums paid towards a life insurance policy qualify for tax deductions under Section 80C with a limit of `1 lakh in a financial year.
• If the premium paid exceeds 20 per cent of the sum assured of the life insurance policy, the amount eligible for tax deduction under section 80C will be limited to 20 per cent of the sum assured.
• The proceeds from the maturity or claims on a life insurance policy are exempt under Section 10(10D).
When Buying the Policy
Unlike traditional plans where a sum assured decides the premium, Ulips work the other way around wherein the premium that one pays dictates the extent of cover that is offered. As policies can be of regular premiums or a one-time single premium, the sum assured varies accordingly.
At the time of Ulip sales, the benefit illustration irrespective of the fund schemes that the policyholder selects is based on 6 per cent and 10 per cent return. The policy types are similar to traditional forms such as endowment, whole life and term.
• The commission that agents or brokers receive has to be disclosed as part of the benefit illustration.
• The net yield indicated should include all policy related charges for mortality, morbidity, riders and any investment guarantees.
Points to Ponder
• 5-year lock-in period, including top up premiums
• Any additional premiums or top-ups will be treated as a single premium with an appropriate sum assured
• The grace period for payment of premium for all Ulip is fixed as 15 days from the due date
• Overall charges in Ulips will be evenly distributed during the lock-in period
• Life or health cover could be offered along with the pension or annuity products as riders
• In case of pension policies, no partial withdrawal is allowed during the accumulation phase. The policyholder will have the option to commute up to a maximum of one third of the accumulated value as lump sum at the time of vesting
• In the case of surrender of pension policies, only a maximum of one third of the surrender value can be commuted after the lock-in period, with the remaining amount mandatorily utilised to purchase an annuity contract
• All Ulip-oriented pension plans currently offer a minimum guaranteed return of 4.5 per cent per annum, or at rate as specified by IRDA (Insurance Regulatory and Development Authority) from time to time, payable on the maturity date. IRDA is planning to move to a capital protection regime.
Types of Ulips
There are broadly three types of Ulips that are based on the benefits they offer and are classified as Type I, Type II and Pension Ulips (ULPPs).
• Type I Ulip: In this plan on death of the policyholder the policy pays the higher of the sum assured or the unit value of the investment to nominees.
• Type II Ulip: In these plans on death of the policyholder the policy pays out both the sum assured and the net asset value of the fund the policyholder invested in to nominees. Premiums on such plans are higher than those on Type I Ulips and as investments come at a high level of risk, you shouldn't abandon your policy in the early years.
• Pension Ulips: This type of Ulip combines life insurance and retirement income. The part of this insurance that relates to life coverage is similar to Types I and II: Upon death, the insurer pays the nominees the death benefit; if you live to retirement age, this pension plan pay back the premiums and accrued returns to you in full to buy an annuity.
Caps on Surrender charges
IRDA has stipulated the maximum difference between gross and net yields at maturity based on the policy term as tabulated below.
Further, the insurance regulator stipulates a cap on the surrender charges that insurers can levy on discontinued policies. The charges are to be calculated as below:
Tips and Strategies
• Use the free fund switch option between equity and debt funds to maximise returns.
• Be exposed highly to equity in the initial years and taper towards debt as the policy maturity year approaches.
• Buy policies online to cut on intermediary costs and save on premiums without compromising on extent of cover.
• Use riders to enhance the scope of cover.
For further information on the topic you can CONTACT Prajna Capital on 94 8300 8300 by leaving a missed call.
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