What is ULIP or Unit Linked Insurance Plan

Posted by Ritika Shah on August 9th, 2016

What is ULIP?

A Unit Linked Insurance Plan (ULIP) is a financial product that combines investment as well as insurance.  In an ULIP the premium amount, after deduction of charges, is invested into funds of your choice. The fund could be equity based, debt based etc. The performance of the fund will depend on the market.  You can switch between the funds. The features of ULIP are similar to those of mutual funds except that ULIPs are investment products with insurance benefits. Since Ulips are insurance plans, the gains and maturity proceeds are tax-free under Section 10(10d).  If the life cover is not 10 times the annual premium, you won’t get any tax deduction and the corpus will also be taxable on maturity. The deduction under Sec 80C is capped at Rs 1.5 lakh

How does ULIP work?

When you buy a ULIP you pay the premium just like for an insurance policy. Unlike the insurance policy the premium is not just for insurance but also for investment. After deducting some charges (some in beginning, some during the policy term) and for insurance, the amount left gets invested into mutual fund of your choice. ULIPS have different funds with different risk-return profile. One may have allocation of 80-20 to equity and debt, some other can have 50-50 and some can have 20-80. You can switch between the funds (max 4 free switches in most of the cases, there after some nominal fees)

For example you buy a ULIP for annual premium of Rs 30,000 for 20 years.  The plan will give him a cover of Rs 3 lakh (10 times the annual premium). After charges are deducted, says Rs 5,000, the amount left (Rs 25,000) is invested in a fund. Suppose the fund has NAV of Rs 10. So you will get 2500 units (25,000/10) of the fund. If fund NAV increases value of your fund also increases. So If after a year, the NAV is Rs 11, then your fund value will Rs 27,500(2500 units x Rs 11). This amount is lower than Rs 30,000 which was invested. If NAV has fallen, then the fund value would be lesser.

What are charges associated with ULIP?

Basic Charges associated with ULIP are:

Premium Allocation Charges: These charges are deducted upfront from the premium paid by the client. These charges account for the initial expenses incurred by the company in issuing the policy-for example Cost of underwriting, medicals & expenses related to distributor fees.

Policy Administration Charges:  These charges are deducted on a monthly basis to recover the expenses incurred by the insurer on servicing and maintaining the life insurance policy like paperwork etc.  They could be flat throughout the policy term or vary at a pre-determined rate.

Fund Management Charges: A portion of the ULIP premium, depending on the fund chosen, is invested either in equities or debt (bonds, money market instruments etc.) or combination of these. Managing these investments incurs a fund management charge (FMC). The FMC varies from fund to fund even within the same insurance company depending on the underlying assets in the fund. Usually a fund with higher equity component will have a higher FMC.  These charges are deducted for managing the funds before arriving at the Net Asset Value (NAV). The fee is charged as a percentage of funds under management. As per IRDA ULIPS cannot impose fund management fee of more than 1.35% per annum.

Mortality Charges:  Mortality expenses are charged for providing a life cover to the individual and are deducted on a monthly basis. The expenses vary with the age and either the sum assured or the sum-at-risk (which is the difference between sum assured and fund value of the insurance policy of an individual).  Typically, it is arrived at by factoring in your age, mortality tables used by the industry and also the company’s own claim experience. Though the mortality charges for a simple term plan and a Ulip should be the same, some insurers levy differential rates.

What are the types of ULIP?

Depending on the death benefit, ULIP are categorized into two broad categories:

Type I ULIP: The death benefit is equal to higher of Sum Assured or fund value. The mortality charges go down as the fund value goes up. Let us say  person buys a type I ULIP that gives her a sum assured of Rs. 5 lakh for an annual premium of Rs. 50 000. In case of death in the initial years of the policy, when the fund value is less than the sum assured, the insurer will pay the agreed sum (which here is Rs. 5 lakh) to the nominee. However, from the time the fund’s value goes higher than the sum assured, the death benefit will be the accumulated amount in the fund. In type I ULIPs, the mortality charge keeps reducing year after year as the sum at risk reduces. Sum at risk is the difference between the accumulated fund value and sum assured under the policy.

Type II ULIP: The death benefit is equal to both Sum Assured and fund value.  Suppose one has taken a type II ULIP for sum assured of 5 lakh, the insurer would give the nominee both the sum assured of Rs.5 lakh and the amount accumulated in the fund as on the date of death. Premiums on Type II plans are higher than those on Type I Ulips. Type II ULIPs also see the mortality rate increasing with every policy year (older the insured gets, higher the risk of death).

A Ulip Plan Comparison is insurance cum investment plan and returns solely depends on the market performance.

The money is invested in debt, equity and hybrid funds which can be chosen as per risk capacity. One can switch between funds

You can withdraw the money but only after the lock in period (currently 5 years).

ULIps offer tax benefits under section 80C.

Unit Linked Plans (ULIP) allows you to switch your investment between the funds linked to the plan.

Charges in ULIP include mortality charges, premium allocation charge, fund management charge and administration charges.

Source: http://www.bemoneyaware.com/blog/what-is-ulip-or-unit-linked-insurance-plan/

Ritika Shah

About the Author

Ritika Shah
Joined: July 7th, 2016
Articles Posted: 22

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