This article outlines the benefits of investing in a ULIP that is both an insurance and investment
Insurance has long been an instrument of risk mitigation, an investment avenue, and tax-saving option. Insurance companies offer investment plans that give investors the option of choosing the risk exposure in the insurance policy. This affects the returns offered by the policy. This sort of a plan is called a unit-linked insurance plan ULIP).
ULIPs are dynamic plans and flexible by nature. Hence, they allow changes and offer a high degree of customisation, as opposed to most of the financial plans that once purchased cannot be modified. It is because of the embedded characteristics of transparency, flexibility, liquidity and goal-based savings that ULIPs have emerged as a preferred investment option.
These plans offer:
• Flexibility
• Transparency
• Tax benefits
• Savings
• Capital appreciation
Insurance and risk cover
The premiums paid by investors are divided into two elements: One is pportioned towards the insurance premium or the risk cover. The balance goes into the investment part. The investment portion of the insurance premium is not 100 percent. In case of death, the nominee gets the sum assured or the net asset value (NAV) of the fund, whichever is higher. Thus, the investment plan gives complete protection to the investor.
The investment portion of the premium is invested in different financial market instruments - debt, equity etc. The risk and returns on these depend on the risk and returns of the underlying instruments into which the investment goes. These underlying options give the advantage of being able to shift money from high risk funds to low risk funds based on the market conditions and the investor's risk appetite. However, switching between options has some limitations and charges, and reduces the returns to the investor.
Flexibility
Underlying funds may be either equity or debt, or a combination of these. Accordingly, the risk exposure as well as the returns from the plan tends to vary. Insurance companies provide different underlying fund options to investors. These may include debt, equity, government securities or money market instruments. The investor can switch between fund options any time during the policy years. The exposure can vary from zero to hundred percent in equity or debt, with and without various combinations of debt, cash or bonds.
Custom-made options
Some plans give the option to create customised asset allocation by investing in any combination of underlying options. Others may offer funds which are completely focused on money or bond markets. Some plans also give a top-up option in which an investor can put additional amounts into the policy. The investor can also withdraw some amount from the plan any time during the course of the policy.
There is always a difference between the NAV at which one buys and the NAV at which one sells. Thus, when one switches from one fund to another or in case of buying a fund, the bid-offer spread needs to be taken into account. Investors should also consider the withdrawal charges involved and the benefit derived out of such transactions.
An additional fee is associated with the management of the various fund options. The fund management expense can vary from fund to fund. Investors can track the value of the underlying fund at the end of the day based on the NAV of the fund.
These plans tend to be better than the pure vanilla insurance plans because they are more flexible, transparent and easy to understand. They give the investors more flexibility to choose investment options. Investors can shift money between fund options any time. An investor may initially choose a debt fund and later switch to an equity fund or vice versa (at a switchover charge). Some free switchovers may also be allowed.
So, the funds are not blocked in one particular avenue and one can take advantage of the ups and downs of the various underlying financial instruments.
Some factors to keep in mind while choosing a plan:
Requirements and risk profile
Identify a plan that is best suited to your requirements of money, keeping in mind your risk appetite.
Check costs
These would include all the charges levied on the product over its tenure and not just the initial charges - fixed administrative charges, fund management charges and mortality charges. Mortality charges are charges for the cost of insurance coverage and depend on a number of factors such as age, amount of cover, state of health etc.
Evaluate performance
Compare the performance of the plan with benchmark indices like BSE Sensex or Nifty over the past two or three years to get an idea about the performance vis-avis these indices.
