According to IRDA, “ULIP is an abbreviation for 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 Remember that in a unit linked policy; the investment risk is generally borne by the investor.”

However, ULIPs are largely sold as solely investment products. So strong is their positioning that a larger share of retail investors’ money enters the market through ULIPs than through pure investment products like mutual funds. This article takes a look at where we might be getting it wrong.

ULIPs or Unit Linked Insurance Policies, are, as the name suggests, insurance policies with a portion of the premium invested in the market. As only better informed retail investors would know, this is not principally different from a traditional insurance policy. Traditional insurance policies also invest a part of the premium in the market (that’s where our bonuses accrue from); the biggest difference here is that with a ULIP, the investor is aware of how much of his/her premium is invested in the market and gets to choose between fund options that the policy premium will be invested in. Many additional flexibility and control-related features have also been introduced with ULIPs which do not apply to traditional policies – but again, the benefits would be in comparison to other insurance products.
Why then are ULIPs sold primarily as an investment vehicle?  Why are they often compared with mutual funds instead of other insurance options?  We believe that they are two different products, serving different investor needs and should not be sold as alternatives. We take a look at ULIPs in comparison with mutual funds based on some common parameters to understand these differences.

Objective

The first question that an investment expert would ask you while evaluating product options is “What is your investment objective?” All available products in the market are structured to meet a specific investor need – and the costs, tenure, risk, etc., of that product are structured accordingly.
ULIPs are an insurance product, meant primarily to provide you with an adequate risk cover. Mutual funds are an investment product designed for wealth building. The fact that ULIPs may also provide growth in capital should not confuse you. In fact, a rule that a lot of expert investors follow is that the simplest products usually suffice to meet our objectives, are easy to understand and manage, and are the most cost effective.
Considering cost and liquidity parameters,  ULIPs may not be  the most appropriate investment option if you are seeking equity market benefits.

Cost

When investing in a product there are two ways of evaluating the costs involved:

1. How much of what I am putting in will be invested for me?
2. What are the management fees, hidden charges, commissions that I may not be aware of?

Liquidity

While an investment may mature at a much later date, it becomes liquid from the time it allows you to exit the investment at minimal or zero cost/penalty. Ease of redemption and time taken to get proceeds are also taken into account.

Mutual funds offer a range of products with liquidity to suit different investor needs, with standard and transparent regulations for redeeming your investment. Liquid funds offer complete liquidity (you can invest and redeem in a matter of days), while most equity and balanced funds allow redemption after a year of investment with no exit load. This practice is mainly to discourage investors from redeeming within a short period of time as equity is for long-term investing.

For investors looking at medium to long-term investment horizons, there are funds like long-term bond funds, FMPs (fixed maturity plans), closed-ended equity funds, etc., which have specified lock-in periods. ELSS funds (equity linked savings schemes) are tax-saving investments under section 80C and have a lock-in period of three years.

With ULIPs, liquidity is not a very transparent issue. You need to evaluate the following:

• After how many years is surrender of the policy allowed
• After how many years can you surrender the policy at zero surrender charge
• At what point does surrendering your policy incur you the least loss [As explained earlier, in ULIPs costs are heavier in the earlier years of the policy, meaning the yield on your investment can be negative also.]

As an example, we present the following Generic Benefit Illustration we found for the SBI Life - Smart ULIP on the SBI Life website. The insured is a 40-year old male, premium is Rs. 50,000 annually and the policy term is 10 years, with premium payable for 5 years.

The illustration assumes a gross return of 10% pa.

Performance

In this section, we keep the structural changes between the two products aside and look purely at the performance of their funds. In ULIPs, like in mutual funds, the “investible premiums” of all policy holders are collected in a fund and invested in the designated market instruments by a professional fund management team.

For the purpose of our comparison, we have taken the funds underlying some selected ULIPs, and compared their performance with mutual funds, bearing in mind that the asset allocation of the ULIP fund and mutual fund being compared is similar*.

* Following is the asset allocation as defined by issuers for the ULIP funds as well as the mutual funds compared here:
HDFC Life Defensive Managed Fund: Money Market and Pub Deposits 0-20%; Govt Securities and Bonds 50-85%; Equity15-30%
HDFC MIP Long Term Plan: Equity: 0-25%; Debt: 75 -100%
ICICI Prudential Life Maximiser Fund: Equity: 0-100%
ICICI Prudential Growth Fund: Equity: 0-95%; Debt: 0-5%
Reliance Life Pure Equity Fund: Equity 60-100%; Debt 0-40%
Reliance Vision Fund: Equity: 60-100%; Debt: 0-40%
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# Performance as at 23 Feb 2010; Source: Data available on insurer websites
## Performance as at 23 Feb 2010; Source: iFAST compilations
^ Returns for more than 1 year have been annualized.

Conclusion

Our objective in this article is not to negate the use of any product, nor is it to prove that mutual funds are superior in all respects to ULIPs. In fact, we say that the two should not be compared, since they serve different purposes and are structurally very different.

For investors with no previous experience with investing, and existing relationships with insurance agents, ULIPs probably are an easy sell. However, with availability of easy and low cost investment products like mutual funds, it is time to educate ourselves, understand our options and choose products based on our need.

If you are looking for insurance cover, intend to retain and maintain that cover over a long-term horizon and would like to have better visibility into where your premium goes to work in the market, a ULIP could be your choice. That again should be decided by looking at other available insurance products. But if you’re looking for an investment in the market with the intention of wealth creation, we recommend that you go in for an investment product, like an equity mutual fund.

IRDA FAQs on ULIPS:
http://www.irdaindia.org/FAQs/faq_ulips221007.pdf