While we do understand that investment in conventional insurance options available to us in India are not shariah compliant. But in this article we try to understand the demerits of investing in ULIPs without getting into aspects of it being non-shariah compliant. Because a lot of people do invest in these instruments either out of ignorance or the compulsion of investing in a tax saving instrument.
When it comes to investment and tax saving instruments a lot of people fall for ULIPs (Unit Linked Insurance Plans), since these are marketed as the best in class investment option that offers ‘best of both insurance and investment.’
But is it really the case, lets find out the facts behind this statement.
The ULIPs are marketed as an investment instrument that offers the benefits of insurance and returns of the equity market. However, behind this marketing the drawbacks have been completely hidden.
- The biggest drawback of ULIPs is that there are high costs associated with these plans. There are some significant upfront charges like management fees , set up charges, mortality fee , fund management fee , monthly management fee,etc.
- All these expenses when combined take away a large chunk of the premium paid and the investment starts at a much lower amount. Not only that some of these charges are recovered upfront for the entire tenure of the plan, which can be upto 30-40% of the total premium paid, making the plan highly unprofitable in atleast the initial tenure (7 to 10 years for long term policies of 15 years plus) of the policy.
- During these initial years the returns on the overall premium paid is not even at the break even level for most of the schemes. It is only at a much later stage in the policy tenure that the scheme would start giving respectable returns on the investment.
- So , in a way once invested the investor is stuck with the policy and even though they may not be achieving the desired returns, but since their overall investment is in negative or below break even they are compelled to keep on paying the remaining premiums to salvage their paid premiums.
- Moreover, these policies are so structured that if you surrender or cancel it prior to the full tenure, stiff penalties and several charges are imposed which significantly decrease the returns on your investment.
- Additionally, in most cases you may not be able to use the funds deposited in these policies either partially or entirely during the tenure . Even if you are able to withdraw funds partially it will significantly affect your returns on the policy.
- Although the insurance/investment companies provide full disclosures before signing up for the plan, but a lot of uninformed investors still fall for these schemes, not understanding the complexities of the financial and glossy terms used to lure the customers.
- Another factor is that, at the time of signing up for the scheme the financial position of the investor may be stable which might change in due course of time. So the 7-10 year period to achieve the break even of investment which may have appeared reasonable at the time of policy purchase may not be acceptable subsequently with the changed circumstances.
- And since these policies offer limited options for early exit without loss the investors get a feeling of being stuck in the scheme.
- In addition to the above, the investment flexibility in ULIPs is limited as the funds are generally invested in other investment funds (mutual funds, etc) with relatively less flexibility available to the investors to suit their risk appetite and investment goals.
- In contrast to this in the traditional methods of insurance and investment the premiums to life cover ratio and the funds to return ratio are much better.For example a term policy of Rs 1 crore can be bought for annual premiums between Rs 8,000 to Rs 15,000 approx. whereas a ULIP plan will cost annual premiums ranging from Rs 25000 to Rs 40,000 approx.
- Also the returns in case of direct investment in equities or even mutual funds is much better than ULIPs returns as the charges in mutual funds are much less.
In conclusion, ULIPs may not be the best investment option for both insurance and return on investment. It reduces the amount of investable funds due to high charges thereby reducing the overall returns on the investment and provides limited control and flexibility to the investor to use their own funds.
It may appear to provide the best of both however, in reality it lacks the best of both.
A discerning investor should think carefully and research well before investing their hard earned money in an appropriate scheme that fits into their risk appetite and financial needs.
