The Unit Linked Insurance Plans (ULIP) has been a popular product in the past. However, in 2010 the IRDA came out with stringent regulations pertaining to ULIPs including ways to avoid mis-selling, extending the lock-in from 3 years to 5 years and more rigorous transparency and disclosure requirements. These factors have largely taken away the charm of ULIPs to a large extent. But there are still a large number of ULIPs that have been in existence over a longer period of time. But first, what exactly is the concept of ULIP and why has it been a bond of contention?
Understanding the controversy surrounding ULIPs..
The Unit Linked Insurance Plan (ULIP) as the name suggests is a combination of an insurance plan and a mutual fund. The contribution that the investor makes towards the ULIP is partially allocated towards premium for insurance cover and partly to long term investments. The investor has a choice between pure equity schemes, pure debt schemes and hybrid schemes depending on their risk appetite. So, it sounds to be a great product then why did ULIPs become controversial?
The reason was mis-selling! ULIPs run huge market risks and these risks were not fully conveyed to the investors when they invested in these ULIPs. These created a lot of disappointment, especially in case of equity exposure. Secondly, there was stiff upfront loading in case of ULIPs and hence even in normal buoyant market conditions, ULIPs took 4-5 years to break even. The big challenge for the regulator was about making these ULIPs more transparent and reducing mis-selling so that customers knew exactly what they were getting into.
What should you do with your existing ULIPs?
Where there are no clear and simple answers to this question, you need to remember that you minimum holding period in case of ULIPs is 5 years. You obviously cannot sell your ULIP before the 5 year lock-in. So the question of what to do with the ULIP only arises once the ULIP has completed the 5-year lock-in. At that point of time, your decision should be driven by the following factors..
Are you actually sitting on a pretty profit after considering all your loading charges? This is a slightly tricky situation. You have borne the brunt of the loads for the first 5 years and hence if your ULIP is performing well compared to peers then you can as well wait for more time and enjoy the no-loads contribution for some more time.
However, if you find that your fund has consistently underperformed the peer group over the last 5 years then there are reasons for you to believe that this underperformance can continue in the future also. There is no point in shifting the ULIP as you will again have to bear the brunt of loading in the new ULIP. You can exit the U LIP and convert it into a combination of a term insurance plan and a mutual fund SIP. More likely you will be better off in the new arrangement.
Most prudent investors begin by creating a financial plan. The question you need to ask yourself is, "how big a component of your financial plan is this ULIP". If the ULIP is a very small part of your long term goals, then it may not affect you materially. But if the ULIP constitutes a significant part of your overall financial plan then your decisions have to be immediate. The weightage of the ULIP in your overall investment mix will be a critical decision point.
If your ULIP has been performing satisfactorily then the next question is whether you have the time and the wherewithal to be a disciplined investor and closely monitor your financial plan. If you can manage that (and that is the desirable situation), then you do not really to go through the pain of ULIPs. You are better off drawing clear Chinese walls between your investments and your risk covers through insurance. In such cases, ULIPs can add little value and you are better off with low-premium term plans and a systematic exposure to equity.
There is one condition when it actually make sense for you to continue with your ULIP; that is when you are not otherwise a disciplined investor and do not bother about the nuances of your long term goals and wealth creation. In such cases, ULIPs do the job of combining your investments and risk cover into a single product and that becomes simpler for you. Of course, this is an inefficient arrangement but in specific cases ULIP is the best option available.
That brings us to the last question; "Does it add value to invest in fresh ULIPs now"? The answer is an emphatic 'no'. The loading is just too steep in case of ULIPs and the insurance cover you get is sub-optimal. Hence it takes a very long time for you to even break even on a ULIP. You are better off treating your investments and insurance separately. That is the way it should be!