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ULIPs - Insurance and Investment - Don't mix them up

ULIPs are expensive and opaque mutual funds disguised as insurance.ULIPs are not smart investments as they have high associated costs. Invest in well rated funds and opt for a term plan for your insurance requirements.

ULIPs have a mixture of the characteristics of both insurance and mutual funds. Crucially, the mutual fund aspect of ULIPs is regulated by the government under a very different set of rules compared to the real mutual funds. From the investors’ point of view (which is obviously the most important point of view), the biggest difference lies in how much of his money is actually used for his insurance and his savings and how much is taken away to pay the commissions to agents and the expenses of the insurance company. The second big, related difference is the quality of the information he is given about his investments.

Mutual funds deduct not more than 2.5 per cent as the agent's commission. And this deduction is 0 per cent (by law) if investors don’t use an agent and go directly to a fund company. In ULIPs, the agents' commission varies, but in the first year, it could be anywhere between 25 per cent and in some cases, 75 per cent. There are a lot of things in finance that are difficult to understand, but the difference between paying 0 per cent commission and 75 per cent commission is not one of those. Even the difference between 2.5 per cent and 25 per cent is pretty easy to understand.

ULIP's NAVs are effectively pre-deduction. The NAV may double, but your investments won't double because the insurance company will reduce the number of units you hold to pay for expenses and commissions etc. This means that the announced NAV has no clear and transparent relation to what the unit holders are actually earning.

We are often told by the insurance industry that this is because ULIPs are a superior product. That's complete rubbish. ULIPs are successful because the ultra-high commissions and charges make insurance agents far more aggressive salesmen than those of any other financial products. These charges also enable insurance companies to spend far more on advertising. All of which is the unitholders' money. The net result of high-pressure sales is that savings that would otherwise have ended up in mutual funds, bank FDs, PPF, post office and many other asset types is ending up in ULIPs, where a good proportion is diverted to pay commissions.

The direction that the India's insurance industry has taken in the last few years is a huge regulatory failure on part of government. This industry was opened up to foreign capital and provided with a relatively lenient regulatory framework so that it could bring insurance to India's under-insured masses. Instead, it has ended up focusing its energies (and capital) on selling expensive and opaque mutual funds that are dressed up as insurance. It's tragic that there is no move to even recognise that this problem exists. Now, even higher foreign ownership is on its way, supposedly because more capital is needed to ULIP the under-ULIPed masses even harder.

It's a necessary expense, like buying a helmet or going to a doctor, but it's not an investment. You need both insurance and investment. To get the best deal in both, don't mix them up.

It's up to you, as an investor, to understand the issues and do what you think is in your best interest.

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