Examining The Use Of Unit Linked Insurance Plans Finance Essay - Free Essay Example

Sample details Pages: 6 Words: 1748 Downloads: 9 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? Insurance products have been typically used for indemnification which thereby meant that it was used for risk management. Since the money gets tied up for long, the prospect of using insurance for investments came into existence. To serve this purpose ULIPs were born. ULIPs (Unit Linked insurance plans) are life insurance policies with the added feature of investments. They thus behave like Mutual funds, to some extent, and thus are also traded like mutual funds. Their value is represented in terms of NAV (net asset value). Since these units are tied to an underlying, their value depends on the value of the underlying at any point of time. Don’t waste time! Our writers will create an original "Examining The Use Of Unit Linked Insurance Plans Finance Essay" essay for you Create order Just like in mutual fund, a pool of the funds collected through the premiums is created, the charges are reduced from it. The policy has the terms for the required returns and risks. The underlying is decided upon keeping this in mind. These funds are compared and traded in the capital markets. Thus, their performance is a function of the performance of the capital markets. Like in case of equity funds, an investor can diversify his portfolio by investing across a wide range of funds. The risk is, after all, borne by the investor. ULIPs provide the investors the flexibility in choosing their investment style. They can pay a lump sum or making premium payments, be it annual, half yearly or quarterly. They can also the premium amounts during the tenure of the policy. This way, if during the tenure an investor has excess funds he can enhance the value of his investments, and on the flip side, a crunch situation allows him to invest lesser amount. He can also shift his funds across various plans like balanced funds, debt funds etc. the cost of doing so is nominal. Expenses Charged in a ULIP Premium Allocation Charge: A percentage of the payments made by the investor are appropriated towards the initial and renewal expenses. The balance is then transferred for the policy. Mortality Charges: These are charges appropriated for the insurance cover. It depends on the factors like amount of coverage etc. basically the factors are identical to a normal insurance cover. Fund Management Fees: Fees levied for management of the fund and is deducted before arriving at the NAV. Administration Charges: This is the charge for administration of the plan and is levied by cancellation of units. Surrender Charges:Deducted for premature partial or full encashment of units. Fund Switching Charge:Usually a limited number of fund switches are allowed each year without charge, with subsequent switches, subject to a charge. Service Tax Deductions:Service tax is deducted from the risk portion of the premium. This forms the led up to the comparison between a ULIP and a balanced fund. What is a balanced fund? A balanced fund is a mutual fund that invests in equities as well as debt instruments. The purpose of the balanced funds is that it combines best of both worlds. It ensures a fixed and permanent flow of income through the debt investment side and benefits of capital appreciation through the equity investment side. A balanced fund usually invests 40-60% funds in the equities and the remainder in the debt markets. Comparison between balanced fund and ULIP The major benefit of a balanced fund over the ULIP is that it is low cost compared to the ULIP. It has a cap on its capital at 2.5%. ULIP on the hand has a lot of charges accruable to it. The charges have been mentioned above. The utility of ULIPs is high only if u plan to remain invested for 8-10 years. ULIPs have a short history and returns can vary hugely between one scheme and another. In the case of balanced funds, you can choose to take a shorter-term approach, without worrying about the impact of costs. Most of the ULIPs are sold because of the three year lock in period.   This facilitates continuation of life coverage till there is enough fund in your account to cover the mortality charges.   Keep in mind that you may lose some or all of your money if you stop paying regular premium at least for ten years Here is some data on how balanced funds and ULIPs have performed. Balanced Fund The HDFC Prudence Fund and HDFC Balanced Fund have provided robust returns of 16% over the past three years. The Canara Robeco Balance Fund, DSP BlackRock Balanced Fund and the Birla Sun Life 95 Fund have also yielded decent returns of 13% over the past three years. The average expense ratio of these funds is 2.5%. ULIPs HDFC Balanced Managed InvestmentÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬Life has yielded 11% returns over the past three years. ICICI Prudential Balancer II has yielded 11.75% over this period. Factoring the annual charges associated with these plans, the actual returns are much less. If you want life cover, you should, instead, opt for a pure term insurance policy. But if you are on the lookout for relatively safe and steady returns, you would be better off with a balanced fund rather than a ULIP Ulips are not easy to understand. Not many investors know about extrapolation of returns and can use spreadsheets to see how well their Ulips stack up. Besides, comparing Ulips is almost out of the question, no matter what the agent says. But investors dont seem particularly bothered about these negatives. The person who seeks advice, opinion and second opinion when hes buying a camera, blindly signs any form his agent hands out as long as he hears the magic words good returns . Luckily, the industry and the regulator are concerned about this lack of knowledge, and they are doing what they can to improve investor education. Till a couple of years ago, Ulips were shrouded in mystery; nobody knew how the insurers charged for expenses, how the policies worked or what benefits were offered. Nobody seemed to want to know either. Investors were happy to believe the overzealous agents, who claimed the plans would give at least 30% returns. That led to rampant mis-selling, but investors remained blissfully ignorant. To check mis-selling, The regulator insisted on a 15-day free look period, allowing buyers to return policies that did not suit them. Today, several insurance companies offer this feature for a month. Then IRDA also insisted on the agents providing the investors a policy illustration with a 6% and 10% return, standardising all charges across insurers, and a sales guideline that every agent had to follow. This is a first as no other financial product comes with an industry sales guideline. Despite the IRDA taking steps to educate consumers, theres a lack of knowledge about this product. An online survey on life insurance shows that over 50% of the respondents own a ULIP; most of them, however, had no clue about the amount of life cover they had. The benefits of ULIPs can be presented as: Long term investment plans Insurance and investments combined together With the cap on commission and pricing coming into picture, they become nearly as fair priced as MFs Like warren Buffet said, it is good to start early. The ULIPs help you to start investing early on itself Once you clearly understand the fine print of any ULIP policy, it becomes a useful product for long term investments. The dividend payout tax sometimes discourages policies from paying out dividends. But this does not affect the returns for an investor because the retained amount gets reinvested and ultimately goes to the investor himself The premium ULIP charges for providing insurance cover is considerably lower than what you would have to shell out for taking an independent policy with LIC. For instance, for a target amount of Rs 50,000 in a ten-year plan, assuming that you enter it at 26, ULIP deducts Rs 55 towards annual insurance premium. Whereas the annual premium for a similar fixed-term life cover from LIC would be in the range of Rs 1,000. Drawbacks of ULIP Liquidity: The ULIPs lead to a lack of liquidity since the funds once invested in the fund get locked in for a period of at least 5 years. Withdrawing before this means you would be foregoing the tax benefit attached to the schemes. Some claim that this lock in period is less than PFs, however it is also a much larger period than other schemes. Plus even beyond this, a penalty of 0.5% of the target amount is deducted for early withdrawal after 5 years. To improve this situation, a new policy to allow investors to withdraw after 7 years in a 10 year policy and after 10 years in a 15 year policy. They just need to maintain a minimum balance of rupees 5000. Performance: ULIPs were offering a return of 13% under the previous method of administered pricing. But now with the switch to NAV based system, this becomes irrelevant since it has become a dunction of the unitÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒâ€šÃ‚ ¢s fund management skills and also the debt market conditions. Size: The size of the funds (5000 crores in 2001) becomes a handicap for the fund managers as it impedes the maneuverability of the portfolio. It had invested 46% in equity which amounts to around 2200 crores. This made it the largest equity oriented fund in operation. This made it impossible to indulge in transactions without impacting the price of the stocks. Given the lack of depth in the debt market, the debt portfolio of Rs 2,679 crore, could prove to be even more of a white elephant. Moreover, as of December 2000, around 6 per cent of the NAV was set aside for non-performing assets. Insurance cover: Whats it worth? Several tax saving plans are available in the market. Assuming that they are all at least as efficient as the ULIPs, the only differentiating factor remains is the insurance cover provided by the scheme. Out of the annual payments a small amount is deucted each year for the insurance premium and the remaining is invested into the fund. However, the cover comes with some very restrictive terms. One, it is restricted to the tenure of the plan. Two, you will be eligible only to 50 per cent of the target amount, in the first six months of your entry into the plan. Three, the insurance cover at any given time is equal to the difference between the target amount and the contribution paid. The contribution you paid will be received in the form of units to your credit, which you would be entitled to, in any case. Four, women without an independent source of income are eligible only for a cover of Rs 40,000.