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Unit Linked Plans

Unit-Linked Insurance Plans (ULIP)

Unit-linked insurance plans, ULIPs, are distinct from the more familiar ‘with profits’ policies sold for decades by the Life Insurance Corporation. ‘With profits’ policies are called so because investment gains (profits) are distributed to policyholders in the form of a bonus announced every year. ULIPs also serve the same function of providing insurance protection against death and provision of long-term savings, but they are structured differently.

In ‘with profits’ policies, the insurance company credits the premium to a common pool called the ‘life fund,’ after setting aside funds for the risk premium on life insurance and management expenses. Every year, the insurer calculates how much has to be paid to settle death and maturity claims. The surplus in the life fund left after meeting these liabilities is credited to policyholders’ accounts in the form of a bonus.

In a ULIP too, the insurer deducts charges towards life insurance (mortality charges), administration charges and fund management charges. The rest of the premium is used to invest in a fund that invests money in stocks or bonds. The policyholder’s share in the fund is represented by the number of units. The value of the unit is determined by the total value of all the investments made by the fund divided by the number of units.

If the insurance company offers a range of funds, the insured can direct the company to invest in the fund of his choice. Insurers usually offer three choices — an equity (growth) fund, balanced fund and a fund which invests in bonds. In both ‘with profits’ policies as well as unit-linked policies, a large part of the first year premium goes towards paying the agents’ commissions.

ULIPs and Mutual funds

In structure, yes; in objective, no. Because of the high first-year charges, mutual funds are a better option if you have a five-year horizon. But if you have a horizon of 10 years or more, then ULIPs have an edge. To explain this further a ULIP has high first-year charges towards acquisition (including agents’ commissions).

As a result, they find it difficult to outperform mutual funds in the first five years. But in the long-term, ULIP managers have several advantages over mutual fund managers. Since policyholder premiums come at regular intervals, investments can be planned out more evenly.

Mutual fund managers cannot take a similar long-term view because they have bulk investors who can move money in and out of schemes at short notice.

Why do insurers prefer ULIPs?

Insurers love ULIPs for several reasons. Most important of all, insurers can sell these policies with less capital of their own than what would be required if they sold traditional policies.

In traditional ‘with profits’ policies, the insurance company bears the investment risk to the extent of the assured amount. In ULIPs, the policyholder bears most of the investment risk.

Since ULIPs are devised to mobilise savings, they give insurance companies an opportunity to get a large chunk of the asset management business, which has been traditionally dominated by mutual funds.

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