Costs and Charges in a Unit Linked Insurance Plan
While we are on the topic of ULIPs and after having discussed and understood the working, features and benefits of a ULIP in the last two articles, it is also essential to know what are the various kinds of expenses and charges involved with a ULIP. Though ULIPs are transparent and the client gets to know exactly how much of his premium goes towards charges once he has taken the policy, Insurance Companies seldom talk about it in detail while marketing and selling their policies. Unit Linked Policies with huge recurring expenses eat away a major portion of the profits earned by way of NAV appreciation.
- Premium Allocation charges – These are charges to cover the running expenses of a policy and to pay for issuance and distribution commissions. These are a percentage of the regular/single premium paid and are usually high in the first year. For Example – If a product has an allocation charge of 5 % in the 1st year, an amount of Rs 5000 would be deducted from the first annual premium of Rs 100000/- towards this expense.
- Policy Administrative charges – These are levied for the administration of the policy – IT, operational etc. These charges usually get adjusted in Unit Value or the NAV, and the NAV is declared after adjusting these costs.
- Fund Management Fee – All Unit Linked plans have underlying funds constituting of various financial instruments like equity, debt, money market etc. The Fund Management Fee or FMC is levied to pay for managing these instruments – cost of buying and selling them for various funds. The fund option which has a higher percentage of equity would have higher charges.
- Mortality charges – This covers the cost of providing life protection for the insured and is expressed as per thousand of the Sum Assured or life cover. For example if a person aged 35 buys a ULIP with a life cover of Rs 10 Lakhs and a mortality charge of 1.5 , the recurring mortality charge would be (1.5* 10Lakhs)/1000 = Rs 1500.
- Rider charges– These pay for other protection benefits that the policyholder has chosen- accident benefit, critical illness etc.
- Surrender charges – If the policyholder wishes to close the policy or withdraw partially during the term, this charge may apply. Usually this charge is applicable only for withdrawal in the first few years.
- Transaction charges – These are specific charges levied when the client does transactions like switching between funds or top ups.
What makes a Unit Linked Insurance Plan (ULIP) so popular
Over the last few years ULIPs have become the most popular category among the insurance products.
The reason? They provide multiple benefits and have various features and options to meet the specific needs of each client.
- Life Protection – A person’s life protection needs depend on the stage of life he or she is at- young and just started working, married with children, nearing retirement etc. A ULIP allows one to choose the death benefit (subject to a stipulated minimum) which is adequate enough and also maintain a balance between life cover and savings.
- Investment/Savings – A ULIP provides the client with the option of investing as per his or her personal risk profile in the equity markets, debt markets, or a mix of the two.
- Switch option – The client can switch between the funds and manage his portfolio actively. For instance, if he finds a substantial increase in the fund value due to a boom in the equity markets, he can switch a part of it into debt and thus lock-in/protect his profits from market fluctuations. The switch option can also be used to change the fund option for future premiums as the risk orientation of the client changes.
- Cover Continuance /Premium Holiday – Insurance policies are long term contracts. Sometimes, the client may find himself facing a situation where he may find it difficult to pay future premiums. This option gives client the option of paying only for a limited number of years, or stop payments for sometime and resume when it is convenient.
- Transparency – In a traditional insurance plan, it is difficult to determine the accrued value of the policy. However, in a ULIP the investment is represented by allocated units and a NAV which is a real time indicator of the value of the investment. Hence a policyholder can easily find out the value that the policy has accrued on a certain date.
- Riders for extra benefits – Riders are extra benefits which can be attached to a policy for extra protection for a nominal charge. The client can choose from waiver of premium, disability benefit, accident benefit, critical illness riders etc.
- Liquidity – A Unit Linked Insurance Plan allows the policy holder to withdraw partially or fully (as per the specific policy plan) in times of emergency without any penalty.
- Tax Benefits – Annual premium payment up to Rs 1 Lac is eligible for tax benefit u/s 80 C and the maturity benefit is tax free u/s 10( 10D) subject to the premium not being more than 10 % of the life cover.
How does a Unit Linked Insurance Plan exactly work?
Unit Linked Insurance Plans (ULIPs) are aggressively marketed by Insurance companies as investment plans with a life cover and benefits like flexibility, market linked returns and transparency. Thanks to it, most of us are quite likely to have invested in one at some point in time.
Here is how your ULIP actually works and how and where does your money get invested from the date of payment of premium till maturity.
- Choose the premium amount, the amount of insurance you need (subject to a minimum and maximum amount as per IRDA guidelines).
- Decide the policy term and the portfolio strategy (choose from the available combinations of debt/equity) for investment.
- The premium amount less the charges is invested in to the fund of your choice.
- In case of the unfortunate death of the insured during the policy term, the insurance amount plus the accumulated fund value is paid to the nominee.
- If the insured survives the policy term, the Fund Value is paid on maturity.