Unit Linked Insurance Plans (ULIPS) are hybrid products that mix life insurance and investments. Like most life insurance products in the market, these offer life cover along with investment. However, it is left to the policyholder to make the investment choice from the available fund options, thereby transferring the risk of investment to the policyholder. Funds can be equity-oriented, debt-oriented or a combination of both equity and debt. These policies may be more profitable than a traditional insurance policy, but also carry a higher risk. While it is good to understand what a ULIP means, it usually makes more sense to keep your insurance and investments separate.
Capital Protection and Inflation 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. 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.
The minimum sum assured/death benefit is guaranteed and the premium is fixed for the tenure of the policy. Returns on the investment portion are market-linked and hence not guaranteed.
ULIPs are liquid only after the lock-in period of five years. Liquidity is achieved by redeeming units in which the premiums are invested in. One can also make a 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 a loan.
One can surrender or terminate the policy at a financial loss.
- The insurer will credit and refund the proceeds of the discontinued policy to the policyholder only on completion of the lock-in period.
- 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 4 per cent per annum.
Premiums paid towards a life insurance policy qualify for tax deductions under Section 80C with a limit of Rs 1.5 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. For policies issued on or after April 1, 2012, the above mentioned limit of 20 per cent has been changed to 10 per cent. The proceeds from the maturity or claims on a life insurance policy are exempt under Section 10(10D).
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: Upon the 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: On the death of the policyholder, the policy pays out both the sum assured and the net asset value (NAV) of the fund the policyholder invested in to nominees. Premiums on such plans are higher than those on Type I ULIPs and investments come at a high level of risk.
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 where upon the death of the policyholder, 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.
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 a 4 per cent and 8 per cent return on the premiums and investment, respectively. The benefit illustration also discloses various charges like policy administration charge, fund management charge, premium allocation charge, etc.
ULIPs may seem like the perfect solution to your need for both insurance and investment. However, it is important to recognise that ULIPs have their limitations. If you were to buy a pure term cover instead, this will cost you much less and get you better coverage even if you don't earn any returns. At the same time, you can invest in equity through mutual funds or stocks while saving on the high costs of a ULIP. Your total returns will likely be higher this way, while your coverage will be better, too.