As equity market is rising ULIPs are again gaining some attraction. The insurance industry is also pushing with these products especially after new regulation. Although the new ULIPs are launched with rules set in 2010 by IRDA, largely these products have been sold on three important elements- High Returns, High Liquidity and Combo of investment cum insurance.
Now the low cost is the prominent selling point. The push on this factor is not without reason .The charges in ULIPs were the primary reason why insurance regulator stepped in. The commissions use to be the bulk of these charges and actually the main villain for misseling. Although rest of the charges also contributed to higher cost but they did not got much of attention since ULIPs were either withdrawn or contribution stopped after few yeasr as investors became aware.
Since ULIPs has come out with their new avatar it is very important to understand all the charges because they will play an important role in pulling you for investments.
Here are 5 charges in ULIP that matters to you and should be in your knowledge-
Premium Allocation (Upfront) Charges
Initially these charges were as high as 70-80% in first year. Even in 2nd and 3rd year major chunk of your premium was deducted in these charges. As a result there was hardly any money which went for investment in first few years. This has been curbed now by linking the commissions to the term of the policy and so upfront charges have reduced.
If premium allocations charge is present in any ULIPs then the amount going towards investment is after deduction of these charges. In plain simple terms if you pay Rs 10000 and 20% is premium allocation charge then R 2000 will be deducted and R 8000 net will go towards investments.
Fund Management Charges
When a company manages your investments then it incurs various cost such as the salary of the team, brokerages on buying selling stocks, etc. To recover these cost a fund management charges is levied. These were also high initially wherein equity funds management charge went beyond 2% while debt funds beyond 1.5%. In new regulations for ULIPs IRDA has restricted the total expenses company can charge. As an investor you need to understand that FMC is being deducted every year from the corpus you have accumulated. It is deducted from the total corpus of the scheme and distributed proportionally. Since it is a recurring expense it gives an impact on the return in the longer term. Higher FMC means the net accumulation will be lower.
Policy Admin Charges
There are various cost which company has to incur while managing your insurance policy. Sending you policy documents, reports, letters for comminications, etc. The policy admin charge goes towards such expenses. This is the only charge which you see being deducted from your investments on a monthly basis. But it’s not the money which get reduced. Instead the insurance company deduct the equivalent number of units from your policy fund. If policy admin charge is very high it can be a big blow for the actual fund value you will receive since the units are being cancelled from your investments. So as an investor you have to compare and see how different companies are deducting as PAC.
Mortality charges pertain to the life insurance coverage company is giving you in the policy. This is the money your family will receive if you die tomorrow. In simple terms this is the cost for providing you a term insurance within the ULIP. Since this charges is directly proportional to the sum assured the higher it is the higher will be the mortality deduction. However there are two type of ULIPs which you will come across – Type I which pays the sum assured or fund value on death while Type II pays Sum assured and fund value. The Type II is costly since the mortality charge remains till the payment. But in type I ULIP the mortality charge is replaced by the fund value as it exceeds it. So effectively no charge is deducted once fund value is more that it and so these type of ULIPs are cheaper.
There are surrender charges when you wish to discontinue your ULIP policy before the term. When all other charges are taken in consideration then this can also have a larger impact on your ULIP policy especially if you wish to exit. The surrender charges are high in the initial years and gets down to zero going forward.
How These Charges Impact?
The impact of charges in ULIPs will vary for different age groups. When you are at higher age then mortality rates are high and so presence of life insurance cover will impact your net premium for investment. If you commit a mistake of buying the wrong product and wish to surrender it early then you may have to pay a higher surrender charges. Contrary to this Policy admin and Fund management charges will impact you in the long term as they are recurring. If the charges are high then you can be sure of earning lower net returns. Thus all these charges present in ULIPs will impact your investment in some or other way.
How The Cost Is Reduced?
In 2010 regulations IRDA curbed all the charges in ULIPs. Now the maximum charge an insurance company can levy has been capped at 2.25% for 10 year and more term. Even the FMC has been curtailed to 1.35% now this giving you a benefit in lowering the total cost. The other reduction in cost is happening by eliminating intermediary. Online term insurance was a step towards this direction and response has surely been good. Some companies have now launched ULIPs through this mode allowing them to offer products with lower charges.
Although charges have been reduced there are still many areas which need to be addressed to consider ULIPs a convincing investment. The high exit cost, since you cannot switch between different ULIPs, forces you to rely on the specific company fund performance. Moreover, its difficult to create a diversified investment portfolio from this avenue as in mutual funds. Factor these while you are analyzing to make a choice for investment.
What do you think about ULIPs? Did you invested in any and why?
Share your views in the comments section…
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