Annual premium

Rs 50,000

Sum assured

Rs 2,50,000

Age of the policy holder

30 years

Policy term

5 years

Ranajoy Sengupta, a senior executive with a public sector firm, got a call from a telemarketer offering an investment plan in which he would need to put in a fixed sum every year for three years and get back double the amount after five years.

For a long time, Ranajoy had been wanting to secure his son’s higher education. He found the telemarketer’s proposal appealing and agreed to sign up for a scheme involving an annual subscription of Rs 50,000. He didn’t feel it necessary to learn more about the product.

Next followed the worry. Ranajoy learnt that the product he bought was a unit-linked life insurance plan (Ulip) and he could not withdraw even part of his investment in the first three years. Moreover, only a portion of his annual subscription would be invested.

The two-year payment holiday (the last two years during which Ranajoy won’t be required to invest anything) was also a half-truth because the agent didn’t tell him that an amount equivalent to his annual subscription of two years would be deducted from his accrued fund.

The accrued fund value after five years won’t be even equal to Rs 1.5 lakh that Ranajoy had paid in the first three years!

The moral of the lesson is that one must beware when an agent comes up with such “novel” investment plans.

The telemarketer must be an insurance agent trying to sell a Ulip on a wrong pitch.

Read between lines

Misselling of Ulips is rampant, despite several warnings by the Insurance Regulatory Authority of India.

Ulips are fairly new in the field of insurance — it was introduced in a big way five to six years back.

A sustained boom in the stock markets in the last five years prevented investors from reading the fineprints of the cost structure, risks involved and other critical features of the product.

Neither the insurance companies nor the agents help prospective policy buyers understand the cost benefits and the risk-return profile of Ulips.

The reasons are not far to seek. Companies push their Ulip schemes as investment products rather than as insurance products to gain a higher market share.

The sustained rise in equity prices helped in their sales pitch. Moreover, an insurance company needs to keep aside lesser capital as solvency margin if it has a higher proportion of Ulips in its product mix.

A higher portfolio of Ulips also increases the valuation of an insurance company. This is because in a traditional plan the investment risk is borne by the company, while the policyholder bears the risk in the case of a Ulip.

Insurance agents are more interested in selling Ulips because the average premium size of a Ulip is much higher than that of a traditional insurance product.

An insurance agent, thus, gets a higher commission by selling a Ulip than a traditional policy.

Know the basics

It would be easier to select a Ulip if one understands the cost structure.

Every Ulip comes with a premium allocation charge that differs from insurer to insurer and from product to product of the same insurance company.

This charge is levied directly on the premium paid.

In other words, the insurance company will deduct part of the premium that one pays and invest the remaining part.

The premium allocation charge is hefty, varying from 15 per cent to 40 per cent in the first year — that is only between Rs 60 and Rs 85 is actually invested in the first year for every Rs 100 paid as premium.

Premium allocation charge is deducted in the subsequent years, too, but at a smaller percentage.

It may be 5 to 6 per cent for the second and third year, 2 per cent for the fourth year and fifth year and 1 per cent thereafter.

A higher allocation in the first year doesn’t mean that the insurer is charging less compared with another insurer that allocates a lower proportion of the annual premium towards the investment fund.

A close comparison will reveal that the first insurer may be charging a higher percentage in the following years than the second insurer.

Hidden charges

As in a mutual fund, Ulips also have fund management charges depending on the investment options chosen — growth, balanced or debt.

These charges are deducted from the net asset value of the respective investment options. When an agent talks about an investment plan that doubles one’s money in five years, the agent must be talking about the growth option in which the fund management charge is the highest, varying between 1.5 per cent and 2.5 per cent.

There are also the regular monthly charges, such as policy administration charge and mortality charge, which are deducted by knocking off units from the investment fund.

Because of this, the NAV of a Ulip doesn’t reflect the accrued investment in the policyholder’s fund. The accrued value will be lower than what the NAV reflected (see table).

Hence, one needs to do a proper homework before jumping into the fray to buy a Ulip.

*Premium allocation charges are: 20% in the first year, 7.5% in second year and
4% in the third year
**Policy administration and mortality charges
The calculation is done on the basis of costs of a standard Ulip of a prominent private
life insurance player. The rate of return is assumed to be 10% per annum