Explanation of ULIP with example

ULIP or Unit Linked Insurance Policy is always in news from the very beginning of its launch in India. Some are in its favour while some critizes it. Let us  try to understand the basics of ULIP and how it works.

When you pay your premium in ULIP, the company deducts some money from it and invest the balance amount in the fund chosen by you like equity market etc. The money that is deducted from your premium amount is called charges. The various charges are: Premium Allocation charges, policy admin charges, Fund Management Charges, Mortality charges and service tax on all these charges.

Some ULIP's have extra charges also like Guaranteed charges.

We'll take one example to better understand the above charges.

Suppose you want to invest Rs.50,000 as annual premium in some ULIP. The brochure says that the charges as per your age and premium amount are 10% Premium Allocation Charges, Mortality charges are Rs.1.72 per thousand S.A., Fund Management Charges 1.5%, Policy Admin Charges Rs.60 per month. These charges are for 1st year and you've taken S.A. as 10 times of your annual premium.

Sounds complex? Let us nake a table to simplify it.

 

Annual Premium50000
S.A. Factor10
S.A.50,000 x 10 = 5,00,000

So, you will get insurance cover of Rs.5 Lacs. Now, coming to charges.

 

ChargesRuleAmt. of 1 yearService Tax RateService Tax AmountNet Amount
Premium Allocation charges10%500010.35155515
Mortality Charges1.72 per 100086010.388.58948.58
Policy Admin Charges60 pm72010.374.16794.16
      
Total    7257.74

So, amount of Rs.7257.74 will be deducted from your annual premium, which comes out to be 42,742.26. Now the fund manager has to manage your fund and he will charge fund management charges of this invested amount, viz. 1.5% of it i.e. Rs.641.13. So, on 1st day of your policy day, your fund value will be 42,742.26-Rs.641.13 = 42,101.12

Now, if you calculate the whole charges at one go, this plan is charging approx. 15.79% in the first year. Similarly, you can calculate this amount for 2nd year onwards. The official illustration, generally given on the company website and with your policy bond shows all these charges in tabulat format for the entire term of your policy.



And because of these charges, ULIP's are not everyone cup of tea. Many investors generally stop paying their premium after they come to know these charges later on. But remember, most of the ULIP's have high charges in the initial 3-5 years and the charges become vert reasonable after that. So, before stopping your premium in ULIP, check if you've already paid the charges.

Sometimes, you want to withdraw money from ULIP. This is possible after the lock-in period is over. The lock-in period of the policy varied from one plan to another. It can be from 3 years to 5 years or even more. 

And if you want to surrender your policy and want entire fund value, you might have to pay surrender charges. I'll take one example for it to explain.

Suppoe the present fund value of your policy is Rs.1,00,000 and the surrender charges as per your policy bond is 30%. So, you'll get Rs.1,00,000-30,000 = Rs.70,000. So, it's important to cheque the surrender charges before going for it.

Also, if an insurance policy is terminated before three years, the tax benefits under Section 80C are reversed. 

Now, check some of FAQ on ULIP. You'll better understand this concept now.

What is ULIP?

ULIP is an abbreviation for  Unit Linked Insurance Policy.  A ULIP is a life insurance policy which provides a combination of risk cover and investment.  

The dynamics of the capital market have a direct bearing on the performance of the ULIPs. REMEMBER THAT IN A UNIT LINKED POLICY, THE 
INVESTMENT RISK IS GENERALLY BORNE BY THE INVESTOR.
 

What is a Unit Fund?  

The  allocated (invested) portions of the premiums after deducting for all the charges and premium for risk cover under all policies in a  particular fund as chosen by the policy holders are pooled together to form a Unit fund. 
 

What is a Unit?

 It is a component of the Fund in a Unit Linked Policy. 
 

What Types of Funds do ULIP Offer?  

Most insurers offer a wide range of funds to suit one’s investment objectives, risk profile and time horizons. Different funds have different risk profiles. The potential for returns also varies from fund to fund.  The following are some of the common types of funds available along with an 
indication of their risk characteristics.  
 
General DescriptionNature of Investments Risk Category
   
Equity FundsPrimarily invested in company Medium to
 stocks with the general aim of High
 capital appreciation   
     
Income, Fixed InterestInvested in corporate bonds,  Medium
and Bond Fundsgovernment securities and other  
 fixed income instruments   
     
Cash FundsSometimes known asMoney Low
 Market Funds — invested in cash,  
 bank deposits and money market  
 instruments   
    
Balanced FundsCombining equity investment with Medium
 fixed interest instruments   
     

 

 

Are Investment Returns Guaranteed in a ULIP?

Investment returns from ULIP may not be guaranteed.” In unit linked products/policies, the investment risk in investment portfolio is borne by the policy holder”. Depending upon the performance of the unit linked fund(s) chosen; the policy holder may achieve gains or losses on his/her investments. It should also be noted that the past returns of a fund are not necessarily indicative of the future performance of the fund.
 

What are the Charges, fees and deductions in a ULIP?

 
ULIPs offered by different insurers have varying charge structures. Broadly, the different types of fees and charges are given below. However it may be noted that insurers have the right to revise fees and charges over a period of time.
 

Premium Allocation Charge

 
This is a percentage of the premium appropriated towards charges before allocating the units under the policy. This charge normally includes initial and renewal expenses apart from commission expenses.
 

Mortality Charges

 
These are charges to provide for the cost of insurance coverage under the plan. Mortality charges depend on number of factors such as age, amount of coverage, state of health etc
 

Fund Management Fees

 
These are fees levied for management of the fund(s) and are deducted before arriving at the Net Asset Value (NAV) .
 

Policy/ Administration Charges

 
These are the fees for administration of the plan and levied by cancellation of units. This could be flat throughout the policy term or vary at a pre-determined rate.
 

Surrender Charges

 
A surrender charge may be deducted for premature partial or full encashment of units wherever applicable, as mentioned in the policy conditions.
 

Fund Switching Charge

 
Generally a limited number of fund switches may be allowed each year without charge, with subsequent switches, subject to a charge.
 

Service Tax Deductions

 
Before allotment of the units the applicable service tax is deducted from the risk portion of the premium.
 
Investors may note, that the portion of the premium after deducting for all charges and premium for risk cover is utilized for purchasing units
 

What should one verify before signing the proposal?

 
One has to verify the approved sales brochure for
 
  • all the charges deductible under the policy
  • payment on premature surrender
  • features and benefits
  • limitations and exclusions
  • lapsation and its consequences
  • other disclosures
  • Illustration projecting benefits payable in two scenarios of 6% and 10% returns as prescribed by the life insurance council.
 

How much of the premium is used to purchase units?

 
The full amount of premium paid is not allocated to purchase units. Insurers allot units on the portion of the premium remaining after providing for various charges, fees and deductions. However the quantum of premium used to purchase units varies from product to product.
 
The total monetary value of the units allocated is invariably less than the amount of premium paid because the charges are first deducted from the premium collected and the remaining amount is used for allocating units.
 

Can one seek refund of premiums if not satisfied with the policy, after purchasing it?

 
The policyholder can seek refund of premiums if he disagrees with the terms and conditions of the policy, within 15 days of receipt of the policy document (Free Look period). The policyholder shall be refunded the fund value including charges levied through cancellation of units subject to deduction of expenses towards medical examination, stamp duty and proportionate risk premium for the period of cover.
 

What is Net Asset Value (NAV)?

 
NAV is the value of each unit of the fund on a given day. The NAV of each fund is displayed on the website of the respective insurers.
 

What is the benefit payable in the event of risk occurring during the term of the policy?

 
The Sum Assured and/or value of the fund units is normally payable to the beneficiaries in the event of risk to the life assured during the term as per the policy conditions.
 

What is the benefit payable on the maturity of the policy?

 
The value of the fund units with bonuses, if any is payable on maturity of the policy.
 

Is it possible to invest additional contribution above the regular premium?

 
Yes, one can invest additional contribution over and above the regular premiums as per their choice subject to the feature being available in the product. This facility is known as “TOP UP” facility.
 

Whether one can switch the investment fund after taking a ULIP policy?

 
Yes. “SWITCH” option provides for shifting the investments in a policy from one fund to another provided the feature is available in the product. While a specified number of switches are generally effected free of cost, a fee is charged for switches made beyond the specified number.
 

Can a partial encashment/withdrawal be made?

 
Yes, Products may have the “Partial Withdrawal” option which facilitates withdrawal of a portion of the investment in the policy. This is done through cancellation of a part of units.
 

What happens if payment of premiums is discontinued?

 
a)Discontinuance within three years of commencement – If all the premiums have not been paid for at least three consecutive years from inception, the insurance cover shall cease immediately. Insurers may give an opportunity for revival within the period allowed; if the policy is not revived within that period, surrender value shall be paid at the end of third policy anniversary or at the end of the period allowed for revival, whichever is later.
 
b)Discontinuance after three years of commencement — At the end of the period allowed for revival, the contract shall be terminated by paying the surrender value. The insurer may offer to continue the insurance cover, if so opted for by the policy holder, levying appropriate charges until the fund value is not less than one full year’s premium. When the fund value
 
reaches an amount equivalent to one full year’s premium, the contract shall be terminated by paying the fund value.
 

What information related to investments is provided by the Insurer to the policyholder?

 
The Insurers are obliged to send an annual report, covering the fund performance during previous financial year in relation to the economic scenario, market developments etc. which should include fund performance analysis, investment portfolio of the fund, investment strategies and risk control measures adopted.
Understanding ULIP in a simple way
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