Unit Linked Insurance Plan (ULIP) – is it really a better option of investment/insurance…

Now a days one of the most hot topics is ULIP… Unit linked insurance plan. What is this plan? How does it work? Is it really beneficial??? Lets check the answers to all these and many more related questions…

Simply speaking, this plan is a combination of life insurance and the mutual fund. From the premium itself, the company deducts some portion against the insurance cost and invests the remaining portion in products like equity, debt, gilt securities etc. according to the predefined objective of the fund.

In other words, it is a money back policy, which is offered by almost all insurance companies, however the returns fully depend on the performance of the investment made by the insurance company out of the funds collected from insurers.

Generally, insurance company offers following options of investments based on the objective of risk and return.
Equity based option
Balance of equity and debt
Debt; and
Government securities

Of the above investments, the first option carries highest risk compared to the second one and second one carries higher risk compared to the third one. The risk is the least in debt investment option while the government security carries no risk they are risk free investments.

However, as we know, risk is inversely related to returns hence as risk decreases, return also decreases thus chances of highest returns are always in the equity based option and the returns decrease as you move further towards risk free investment.

The additional benefit available with the ULIP is that of tax benefit under section 80C of the Income Tax Act, 1961. The whole premium paid to the insurance company is deductible from the gross total income of the individual.

Now let us discuss few shortcomings of the above scheme -

The most important drawback is that the company charges a substantial amount against the insurance risk and hence on an average the least charges are 4% while it increases as you increase your insurance coverage. Over and above the insurance charges, the company charges the administrative cost on monthly basis, which the company adjusts against available units to the investor’s account. Thus the scheme carries the hidden cost of Administrative charges. Most of the times investor comes to know about the administrative charges only when he receives his annual unit statement.
The other important thing is lock in period i.e. once the premium paid then it gets blocked for the period of three years. The option to surrender the policy is available; however in that case, investor looses a handsome return.

The investor can avail the same benefits as that of the ULIP and can earn the higher returns on his investment.
Check out the following example for more understanding-

The individual investor aged 25 years has Rs. 1,00,000/- and he has the following two options of the investments-

Option - 1
Investment in unit linked insurance plan –
Having allocation rate of 94%
Administrative charges of 1% of the sum assured
And insurance coverage of five times of the investment amount i.e. Rs. 5,00,000/- in our case.

Option- 2
Opting for a insurance coverage without money back option; and
Investing the remaining amount in the mutual fund.

Now suppose the investment fetches the returns @ 25% p.a. in both the options.

Thus the benefits in the two options will be as follows-

Option-1

Total amount available for investment = 1,00,000*94% = Rs.94000/-
Investment of the above money @ 25%
Thus returns = 94000*25% Rs. 23500/-
Add- Tax benefit @ 30% on 1,00,000 Rs. 30000/-
Less- Administrative charges@1% of 5,00,000 Rs. 5000/-

Net returns in the hands of the investor Rs. 48500/-


Option- 2

Premium chargeable for the insurance coverage of 5,00,000 = Rs. 1500/-
Net amount available for investment = Rs. 1,00,000- 1500 = Rs. 98500/-
Which is to be invested in Equity Linked Savings Scheme (ELSS)
with entry load @ 2.25%.

Net benefit will be –
Return from investment@ 25% = (98500-2.25%)*25% = Rs. 24010/-
Tax benefit u/s 80c on (98500+1500) @ 30% = Rs. 30000/-
Total return = Rs.54010/-

Net additional benefit over the option-1 = Rs.5510/-

Thus from the example it is clear that the second option is more beneficial that the option one.

While framing the example following assumptions are made-
It is considered that the investor falls under 30% tax bracket.
Education Cess ignored.

Any Comments or suggestions on above are welcome at sagarmadurwar@gmail.com