ULIP: Red flags

Uma Kannan wrote this piece on rediff.com….interesting..she called it “11 reasons not to buy ULIPs”. Easy to identify with some things she says…here it is…it appears in the Get Ahead section of the site..

I am sick and tired of writing about ‘should I buy a ‘ULIP or a MF‘ kind of articles. I know people who buy both, I know people who do not buy both, I know people who swear by either one. It takes all kinds to make the world does it not?

However here are some reasons why I am disillusioned with the industry in general. I started off as a great votary for one life insurance company which came out with plans which had AMC charges of 0.8% (dramatically low) for equity funds. I jumped and bought the product. Then they came out with another double benefit plan – which was unique in its concept of paying an annuity apart from an immediate payment of the death claim. In its original form (as how I bought it) frankly it is a great product if you need life cover and your dependent prefers an annuity because he/she cannot handle investments.

However, as the product grew popular the company added a lot of unnecessary features and dramatically increased the costs. This to me was not very shocking, but unnerved me – tough to make a 30 year commitment to a client with the constant risk of changes lurking. So here are the reasons why I do not like Unit Linked Policies:

1. The terms can change: This is a complete disaster. Once you have bought a product assuming the amc charges are 0.8% you believe it will not change. However, some ‘Relationship Manager’ will show you clause 37 in font size 7 that charges are subject to change. This can change the value proposition completely. It is like Tata Motors saying “in the 3rd year you will have to pay Rs. 1.2 lakhs for servicing the Nano, and servicing is compulsory”. It is baulking.

2. Employees enthusiasm to buy: Many life insurance employees are lateral entrants from the mutual fund industry, or people new to the financial services industry. They interact with mutual fund agents and in great gusto start doing SIPs in mutual funds! The enthusiasm with which the employees buy mutual funds is far, far greater than their comittment to ULIPs! Those who have any life insurance have Term insurance or nothing. No big employee comittment to UL products is visible. I do suffer from short vision, but this is an observation across 3-4 companies.

3. Stuck to the fund manager: Sadly if a fund manager leaves, but you cannot shift to another unit linked plan. In most life insurance companies the equity corpus is small. This means the economies of scale do not kick in, the services of the registrar is not outsourced (so it gets more expensive) and the life company finds it expensive to hire good fund managers. How ever, fund managers quit – hoping to jump into the MF jobs!

4. Large cap bias: One of the main reasons why big mutual funds (like Hdfc Top 200) are beating the index is perhaps the way the index is structured. Currently the index is not doing too well because Reliance is under some growth pangs. Your out or underperformance is decided on the basis of a few stocks – in 2007 it was Bharati and Rcom. In 2009 these 2 shares would have chewed your performance. However the UL portfolios are very heavily loaded towards the tried and tested heavy weights. Hence if you get index out performance you might end up getting poor absolute performance!

5. Too much of the charges are upfront: Oops I promised not to talk about the charges! Well, if too much money goes into the upfront charges not enough of your money goes to work immediately. In a way if you had bought a UL policy in the month of Jan 2009, your NAv would have gone up, but only on 30% of the premium paid – the other 70% is lost to charges. However in 2008  it would have been good – you may have lost less, but still wiped out your capital!

6. Service: Mutual fund services – wheter it is getting the statement, switch, ease of withdrawal are all favoring the mutual fund industry vis a vis the life insurance companies.

7. Construction of the product is too complicated: Understanding an Unit linked plan is really difficult. It is like a constant race. The lesser that the end user understands the greater money the manufacturer, and the distributor can make perhaps?

8. Sales force is OBVIOUSLY focused on earnings: A friend who wanted to invest Rs. 500,000 was sold 4 unit linked plans of Rs. 125,000 premium each – a very inefficient way! However the distributor made far greater money – about Rs. 40k MORE than by selling it as one Rs. 500k plan. This read with clause 7 shows why financial planners who do not sell life insurance plans for a living suggest a simple term plan instead of a complicated UL plan.

9. People who do not understand risk keep money in Unit Linked Plans in debt instruments. This along with high upfront charges ensures that you will never be able to treat this as an investment. At best it is a savings product – and a very inefficient one at that.

10. If you already have a unit linked plan find out the IRR (internal rate of return) on that product. Put all the premia paid in an excel sheet then type the current value (with a -ve sign) – let us say you have invested Rs. 10,000 per annum for 6 years and today it is worth Rs. 65,000 (after 6 years) your Irr would be 2%.

11. It is a rich man’s product: Suppose you wish to invest Rs. 500,000 a year and wish to invest it in 5-6 funds then you can choose to put Rs. 100,000 per annum (or Rs. 8500 per month) in a ULIP. Why Rs. 8500 a month? Simply because the absolute charges (like administration charges etc.) at Rs. 70 a month can really hurt a policy with a lesser premium. A person who wishes to invest only Rs. 100,000 a year cannot afford a UL of Rs. 100,000 p.a! So by the time you have enough money to invest in a UL, you may be say aged 45 years. At that age you do not have too much time for compounding. Heads I win, Tails you lose.

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4 Responses to “ULIP: Red flags”

  1. is it not a copyright voilation you copied some others article as it is and pasted in your blog? I am not questioning you but had a small doubt about this and wanted to ask you.. bcoz some time I also find some intresting articles on net and wanted to post it on my blog but didnt know whether it comes to any copyright violation or not???

  2. uma is a friend…i do not use any other persons article….but otherwise u will have an issue. For example my articles are protected…but somebody can give a link..but not do a cut paste….

  3. After reading your post on ULIP, I am wondering if my ULIP will bear any fruits.

    Regarding the internal rate of return, how did you derived it at 2% IRR (in the above example)

  4. In below article you say ULIPs are good and now it seems this article contrasts your previous article.


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