Why Unit Linked Insurance Plans(ULIPs) are not suitable products

Are Unit Linked Insurance Plans. ULIPs as bad as they are made out to be ?

ULIPs are investment products that combine insurance with investment. Both insurance and investments serve two different purposes – they cannot be combined to make a cocktail you cannot drink.

Any product that begins to digress from the basic concepts of keeping finance simple, meaningful and easy is one which you need to keep miles away from. Let us check why are ULIPs bad ?

Keep products simple

Investing and making money are very simple tasks. You do not need to learn the art of trading on the stock market nor rummage through complex financial products to decipher which one will give you the most return.

If you stick to the basics of disciplined investing, you would belong to a very small group of wise men who will eventually get rich.

And one of the most important financial products you need to have is insurance. The basic purpose of insurance is protection from risk in the event of any loss.

To explain in layman’s terms – if the primary earning member of a family were to pass away, the family would still need money to live life like before. In the absence of the bread winner, life insurance companies come to our rescue and pay that amount.

The fundamental aspect of insurance is you pay premiums for getting yourself insured. If you die, your family gets a lump-sum amount that can be used for all their financial goals in life. If you live, you lose the money. This can be achieved by something called term insurance.

The insurance is investment rut

So why would you want risk cover and try and make some money out of the arrangement at the same time ? Why would you mix insurance with investments ?

We humans cannot let go of any small amount of money. So we opt for the insurance company to return us our premiums, that calls for a term insurance with return of premium. The premium you pay the insurance company in this case will be higher than the earlier option when we did not want any money back.

To give more options to investors, there are endowment and whole life plans which combine investments with insurance. And to take investor’s life to the next level of miser-ability (for lack of a better word), there are ULIPs – Unit Liked Insurance Plan.

ULIPs invest in both equity and debt and in a proportion you ask them to. This is how they are different from endowment and whole life plans which are primarily debt oriented investments. So what’s my issue with them ?

ULIPs are complex products

To begin with, ULIPs are complex products for a layman investor to comprehend. Products which cannot be understood by investors can never be bought  – they will have to be sold.

ULIPs have huge front end charges, sometime as high as 40% in the form of commissions for the life advisor who sold you the product. That is mouth watering by all means.

So your friendly life insurance agent is not going to ask you to take a term insurance that gives him a mere 2-5% earning in commissions. He will missell a ULIP to you and make a killing. And he will tell you that you can get out of it in the next 5 years after the lock in expires. The charges for ULIPs need to be amortised over the life of the insurance plan.

Similarities are drawn between ULIPs and Mutual Funds(MFs) and sold in the Indian market today. But the regulation that governs both are very different.

You could potentially sell your MF with ease, they are even traded on the stock exchange. If you sell off your ULIP, you lose life insurance, and so the very risk you wanted to protect your family against remains as is. You could also lose a great deal of money if you sold off in the earlier years.

ULIPs are not transparent while MFs are. SEBI has clamped down charges on MFs but the same has not been achieved for ULIPs as IRDA has not  moved in swiftly to clear the dirt as we would like them to. ULIPs account for nearly 90% of business for life insurance companies today. And so they are sold vigorously. And missold more vigorously.

ULIPs demand stiff regulation and massive changes. IRDA may be moving to make some amends. But as long as ULIPs continue to mix investments with insurance, which they will always do, they are off my “I Like” list.

Keep things simple in your financial planning. Take a pure term insurance. Invest the rest of the money in mutual funds to earn more than what your ULIP could have earned for you. That’s a discussion on which books can be written and I will leave it for a later day.

So, why do you think why are ULIPs bad products ? Or maybe you don’t !