What’s wrong with a ULIP?

There is a raging debate on ULIPs. Article after article is being published in favour or against a ULIP. Since this is the last leg of the tax saving season, the pitch has become even more shrill.

There was recently an article on ValueResearch about choosing ELSS vs ULIPs and there are angry comments on the article to the extent of accusing the writer of taking sides and not presenting a true picture about ULIPs. Both the camps, for and against, have made their points and it is difficult to ignore either.

If you are not truly aware of what a ULIP today is, you may want to first read another post here.

Now, let’s come to the real issues with ULIPs. What’s wrong with a ULIP?

ULIP – Issue 1

The first issue about ULIP is about its identity. What is it really? Insurance or Investment?

A ULIP is NOT an insurance plan. It is an investment plan. I think it is high time that the regulator rewords the acronym to Unit Linked Investment Plan from the current Unit Linked Insurance Plan.

Calling a ULIP an insurance product is a grave insult to the concept of insurance. As is obvious, insurance is only incidental to a ULIP. It cannot be your insurance product.

Let’s put this into perspective.

Suppose you need a life insurance cover of Rs. 1 crore. I will also assume that your current age is around 35. (You can figure out how much insurance you need with this calculator.)

If you were to use a ULIP to get that cover of Rs. 1 crore, you would need to pay an annual premium of Rs. 7 lacs approx. This is considering the formula of 15 times the premium cover that some insurance companies provide. With others who provide 10 times the premium, the premium would be Rs. 10 lacs, per year. How about that?

OK. Even if your requirement would be just Rs. 50 lacs, the premium would be Rs. 3.5 lacs (15x of premium) or Rs. 5 lacs (10x of premium), per year.

Let’s look at it from another angle. If you were to pay a premium of Rs. 1 lac a year in a ULIP, you would get a life cover of only Rs. 15 lacs (at 15 x) or Rs. 10 lacs (at 10 x).  That’s not enough for your needs.

What are we comparing against? Term plan, of course. In a term plan, a cover of Rs. 1 crore would come for just about Rs. 14k (including taxes).  A Rs. 50 lac cover would set you back by just around Rs. 7.5k.

Did you just rub your eyes?

Yes, you cannot use a ULIP for your insurance needs.

You see, it doesn’t take a Large Hadron Collider to figure this out. Some simple maths and common sense.

ULIP – Issue 2

The second issue with ULIPs is the way they are sold or mis-sold. ULIPs are highly misrepresented to the investor.

I know some of you have been kind to write to me with your queries. There are others I have met in person as a part of our engagement.

One thing common that I have come across is that you were told that you need to pay premia only for 5 years and then you can just let the money grow.

You were also told that you could withdraw your money partially after 5 years, that you could pledge the policy with the bank to take a loan and if you wished, you could even surrender it and get the current value back (subject to some charges).

But that’s not the point. The issue is with what you were not told. You were not told that only if you pay premium regularly for the full term of the policy will you be able to reap the benefits of the policy, if at all. The ‘pay only for 5 years‘ is a gross misrepresentation.

And there’s more that is wrong.

Another selling pitch is that one can make free switches from equity to debt and vice versa without incurring any taxes or charges.

To begin with, almost every ULIP investor I have spoken to, had no idea of which option their ULIP fund is invested in. They just go with the recommendation given by the agent at the time of purchasing and it continues to be their default option.

As you would be aware, there are 6, 8 or 10 investment options available in a ULIP that you can choose from. It almost sounds like a mini mutual fund company in the garb of a ULIP. How is an investor supposed to make the choice in the first place and then further decide when to switch and into what option?

Well, the agent is not helping in case you thought so. Yes, there are some who have made the most of the ‘market timing’ feature. But that’s the point, there are only some. So, this feature also doesn’t add value.

The ULIP camp also talks about low charges that an investor benefits from, when invested for the full tenure. There is this one insurance company that claims to have a fund management charge of only 1.35% (charged on a daily basis) and no other charges except mortality charges on its ULIP product.

OK, I will concede the cost benefit to them. Yes, ULIPs have low charges.

But compared to what?

If you look at a comparable investment such as mutual funds, the direct plans have an annual expense ratio in the range of 1% – 2%. This is coupled with great flexibility. You can switch from a non-performing fund manager to another one. You can redeem your money, in full, when needed, without any penalty and of course, tax-free (when held for over a year).

And yes, there are hybrid funds too with all the favourable tax treatment.

So, is ULIP a bad investment?

I really don’t have a view as such. But I do have a preference for flexibility and for that reason alone I would not go with a ULIP. It now goes without doubt that ULIP is not an insurance product. If you need to plan your insurance, go for a term plan. 

Don’t make ULIP your first or second or even a third investment, for that matter. Go for mutual funds, there is lot more flexibility and variety to choose from. You get the point.

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Between you and me: Do you have a ULIP? How is your fund invested? Have you ever switched or changed your option?

By the way, Large Hadron Collider is the single largest machine in the world and is being used by scientists to find the God Particle.