Unit Linked Insurance Policy

ULIP means 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. In this policy the investment risk is borne by investor.  After deducting the allocation charges a portion of premium paid by investor is invested in equity market in the form of units. The charges are very high like Premium Allocation Charge, Mortality Charge, Fund Management Charge, Policy/Administration Charge.

A ULIP may deduct an allocation charge from every premium collected and the balance is invested in the funds chosen by the policyholder. The units will be bought at the offer price but worth only a lower bid price. The insurer will thus earn the bid-offer spread on each unit purchased. At any given time, the policyholder owns a given number of units, whose unit value would keep changing depending on the performance of the fund. From the fund account, various other charges (administration charges, mortality charges, investment charges, etc) are deducted periodically as per the policy provisions by cancelling an appropriate number of units held by the policyholder, in favour of the insurer.

A part of the policy holder benefits (unit fund) is specified in terms of ‘units’. These units belong to the policyholder and not the insurer. The value will vary with the net asset value (NAV) of the units. However, the insurer is interested in cash inflows and outflows in his account.

ULIP is a hybrid, combining insurance with an investment in a mutual fund. As mentioned earlier, it is closer to a mutual fund than a traditional insurance product. Except for a minor life insurance component, the policyholder bears all the investment risks, just like in any mutual fund.

However, against this modest insurance benefit, the policyholder is charged by the insurer under several heads- allocation charges, bid-offer spread, administrative charges and investment charges, apart from the mortality charges for the insurance. These charges are often deducted in complex ways- some as a percentage of annual premium, some on a fixed basis every month, some as insurance charges on a monthly basis, some on a daily basis as a percentage of fund value and so on. In addition, these charges are subject to revision in future periods, with some restrictions. It is very difficult for a buyer to understand the overall impact of these charges on the value of his account, over several years. For example, a small increase in investment charges as a percentage of fund value can have a substantial impact towards later policy years when fund values are likely to be higher. In addition, to recover their high initial acquisition expenses, ULIPs usually levy surrender penalties in the first few years if the policyholder wants to surrender his policy.

Tax Relaxation on ULIPs

Regular Premiums (other than riders) up to a maximum of 20% the sum assured is eligible for tax rebate under the erstwhile Sec 88. Therefore, if your sum assured is at least five times the annual premium, the entire premium is eligible for tax rebate. Earnings in unit funds under ULIPs accumulate tax free. Provided the premium in any of the years does not exceed 20% of the sum assured, all death, maturity and full and partial withdrawal benefits are eligible for tax relief under section 10(10D) Most of the policy documents say that the risk of any changes in tax treatment is to be borne by the policyholders.

ULIPs are a good investment tool if the equity market is behaving in similar manner all the time. But if the economic policies disturb the market similarly it affects your fund value.  Those who have high risk taking potential and go for ULIPs, otherwise it is not advisable to opt for ULIP. For life insurance always go for term life insurance where coverage is much higher on fewer premiums and for investment search for other investment tools available in the market.