Ch. 1: What is ULIP Plan

A Unit Linked Insurance Plan, or ULIP in short, is a type of life insurance cover that has two sides - Investment and Insurance. Unlike a term insurance plan, a ULIP offers you an opportunity to invest in market instruments to achieve your long-term goals, while ensuring that you have a life cover for your dependents!

Now, what does the term ‘unit-linked’ mean? How do the insurance and investment components of this plan work? What are the benefits that a ULIP gives you?

Read on to know!

A ULIP is made up of two components -

• Unit-Linked Investment
• Insurance Plan

A portion of the premium you pay is used to provide the life insurance cover, and the remaining amount is invested.

Let’s have a detailed look at these components.

1. Unit-Linked Investment
Did you know that a ULIP is the only type of life insurance plan that lets you invest in the stock market? Well, yes! So, unlike traditional life insurance products that offer fixed returns for the premiums you pay, a ULIP’s returns are ‘linked’ to the stock market performance.

A step-by-step guide to what happens when you invest in a ULIP -

• The premiums paid by policyholders like you are pooled together by the insurance company into a market fund.
  The market fund is managed by a Fund Manager, whose primary role is to manage an investment portfolio on behalf of an investor to maximise returns.
• The insurance company offers various fund options. These are a combination of different asset classes, which you can choose from - depending on how much risk you are willing to undertake.
  For instance, when you visit a sandwich shop, you can ask for the bread, sauces, and the fillings you prefer. You might order an oregano-topped bread with veggies and spicy sauces. Or you might order a sandwich with meatballs and barbeque sauce!
  
  Similarly, when it comes to a ULIP, you get to choose the funds you want to invest in - depending on your risk tolerance, life stage, and goals.

Types of Asset Classes

➔ Equity Market Instruments
The premium paid by you is invested in an equity market, i.e., wherein company shares are issued and traded. An equity instrument is subject to higher risks, but has the potential to give you higher returns.

➔ Debt Market Instruments
The premium paid by you is invested in debt instruments. The fund manager lends the money in various forms of instruments to corporates or government entities. These instruments usually generate fixed returns, and hence are considered safer than equity investments. Examples of debt instruments - corporate bonds, government securities, Certificate of Deposit, and other money market instruments.

➔ Money Market Instruments
It is a type of a debt instrument that invests money in short-term money market instruments like commercial papers, bank deposits, treasury bills, etc. These possess high liquidity and tend to offer good returns - therefore, are preferred by conservative investors. The average maturity of a money market fund is 1 year, whereas the average maturity of a debt market instrument could be longer, say 5 years. Also known as Cash Fund or Liquidity Fund.

Okay, so you have invested money in a ULIP and have chosen the fund that suits your needs the best. What happens next?
➔ Conversion into Units
The money gets converted into units based on the Net Asset Value of the fund on that particular day.

Net Asset Value (NAV) is the market value of the fund you are investing on the date of the investment. It is dynamic in nature, changes every day - very similar to say stock prices.

So, Number of units = (Invested Money-Charges)/Net Asset Value

For instance, Ahana purchases a ULIP on 22nd May, 2022. She pays a premium of Rs 45,000. Let’s assume that the NAV on the day of her purchase was Rs 100. Now, say after charges applicable (explained later) on the ULIP, Rs. 40000 is ready to be invested into the fund.

So, the total units she received = (Invested Money - Charges)/Net Asset Value
= 40000/100
= 400 units.

➔ The NAV is market-linked, and hence, the value of your fund changes with it.
The Fund Value is the market value of your investment or the value of the total number of units you hold with the insurance company on a particular day. Since the NAV changes every day and is wholly dependent on the market, the fund value of your investment changes each day too.

Fund Value = NAV x Number of Units

Let’s have a look at Ahana’s example again. She owns 400 units. Assuming that the NAV on 2nd June, 2022 was Rs 1000 -

Fund Value = NAV x Number of Units
= 1000 x 400
= Rs 4,00,000.

Charges in a ULIP
The entire amount you pay as a premium is not invested into funds. To manage the fund, the insurance company will deduct certain ‘charges’.

There are various types of charges that an insurance company may levy. They are -

➔ Premium Allocation Charges
A certain percentage of the policy purchase premium and renewal premium is deducted as a charge to cover expenses like underwriting costs, agent commissions, medical expenses, etc. This charge will be deducted from the premium amount before investing into the fund and converting into units.

➔ Policy Administration Charges
A monthly fee is charged by the insurance company for the administration of your policy. These charges are deducted by cancelling the units proportionately from your selected funds.

➔ Fund Management Charges
Levied for managing your funds and are charged by the insurance company as a percentage of the fund’s value. They are charged before computing the NAV.

Read more about Charges here

Insurance Plan
The insurance component of a ULIP takes care of your loved ones even in your absence - by giving them a death benefit. This money acts as a financial safety net and can be used to cover their expenses (both short-term and long-term), pay off debts and liabilities, and have a secure future without compromising on their lifestyles and needs.

The death benefit may be -
a. Either the sum assured or the fund value, whichever is higher.
OR
b. The sum assured plus the fund value.

A few aspects of the death benefit -

• The sum assured is usually 10 times the annual premium. It can also be a different multiple, say 15 times or 20 times the premium, depending on the product.
• Any withdrawals from your policy fund value, during the 2 years preceding your date of passing away, will be deducted from the death benefit.
• Mortality Charges will be deducted by the insurance company for providing a death cover. The charges may vary across individuals and are dependent on factors like age, gender, etc. Units are deducted proportionately from your selected funds - on a monthly basis.

• Investment Returns (Maturity Benefit)
  This is the primary reason why you must consider buying a ULIP Plan. The maturity amount is paid to you when the policy matures, i.e., when the policy term ends. You shall be paid the fund value as calculated on the policy maturity date. Then, the policy is terminated.

• Death Benefit
  As discussed before, your nominee gets a death benefit if you pass away when the policy is active. This may be -

• Either the sum assured or the fund value, whichever is higher

  OR

• The sum assured plus the fund value

For example, Ramesh buys a ULIP for which he has to pay an annual premium of Rs 1,05,000 for the next 25 years. He unfortunately passes away during the policy term. The death benefit will be paid out to his wife, who is the appointed nominee.

The NAV on the date of purchase is Rs 200.

Assuming that charges have been deducted and Rs 1 Lakh can now be invested -

Hence, the number of units owned by Ramesh = 1,00,000/200

= 500

Let’s see how the death benefit works.

Scenario 1 - The death benefit is either the sum assured or the fund value, whichever is higher

Let us assume that the sum assured is 10 times of the annual premium. So, in this case -

Sum Assured = 10 x Annual Premium

= 10 x 1,00,000

= Rs 10,00,000

The fund value is calculated on the basis of the NAV and the accumulated units. Let’s assume that his plan accumulates an additional 1500 units till the date of his death.

So, the total accumulated units = 500 + 1500 = 2000

Let’s assume that the NAV on the date of his passing away is Rs 400.

So, Fund Value on that date = NAV x Owned Units

= 400 x 2000

= Rs 8,00,000

Therefore, since the Sum Assured is higher than the Fund Value at the time of his death, his wife will receive a death benefit of Rs 10,00,000.

Scenario 2 - The death benefit is the sum assured plus the fund value.

As calculated in the previous scenario, the Sum Assured is Rs 10 Lakhs and the Fund Value is Rs 8 Lakhs.

So, Death Benefit = Sum Assured + Fund Value

= 10,00,000 + 8,00,000

= 18,00,000

His wife is eligible to receive Rs 18 Lakhs as the death benefit.

• Fund Switching

You can shift your money from one fund to another, without having to purchase a new plan. The performance of funds varies on a daily basis, and you can move to a new fund if you feel that your current fund isn’t performing very well and could lead to losses or any capital gain tax implications. This allows you to manoeuvre your funds, either to maximise returns or protect capital depending upon your goals.

Read more about Fund Switching here.

• Partial Withdrawals
  Once your ULIP is active, it starts accumulating a fund value. However, as per regulation, there is a lock in period of 5 years. So, you cannot withdraw or liquidate the accumulated fund value for a period of 5 years after buying the policy.

Once this 5-year period is over, you can start making withdrawals when needed. For example, you require funds for an emergency hospitalisation, to pay off a loan or downpayment, etc.

You can learn more about Partial Withdrawals in our article here. <insert article link>

• Tax Benefits²
  You can avail tax benefits² on the premium you pay, any withdrawals you make, and the returns you or your nominee receive under Sections 80C and 10D of the Income Tax Act, 1961.

• Customization Options

You can customise your ULIP to your needs with the following options -

• Riders

  Add-ons to widen coverage. A ULIP can be customised with an Accidental Death Rider, Waiver of Premium Due To Critical Illness Rider, or a Waiver of Premium Due To Disability Rider. There can be more Rider options, depending on the product.
  
  

• Premium Payment Term
  You can also choose the duration of paying the premiums - according to your convenience and financial situation.

• Single Pay Option: You can pay off all the premiums when you purchase the policy - in one go!
• Limited Pay Option: You can complete all your premium payments in bigger and faster instalments, instead of paying them till the end of the policy term.
• Regular Pay Option: You can pay the premiums as per the regular schedule, i.e, till the end of the policy term.

Premium Payment Frequency
You can also choose how frequently you want to pay the policy premiums - annually, semi-annually, quarterly, or monthly.

Eligibility
There are various factors that determine if you’re eligible to buy a ULIP -

Age
Minimum Entry Age - Can be 30 days or 18 years, depending on the product.

Maximum Entry Age - Generally 60 or 65 years. It can vary (depending on the product) and can range from 45 to 70 years. It may depend on the premium payment term as well.

Income
You may be required to submit your income proof before the insurer issues your policy. This is a part of the financial underwriting process to check if you would be able to pay the premiums till the entire policy duration or premium payment term.

The minimum income criteria may vary across products, insurers, and may also depend on the amount that you plan to invest.

Minimum and Maximum Premium
Minimum Annual Premium Criteria - It can be as low as Rs 10,000-15,000 per annum or as high as Rs 1-2 Lakhs per annum, depending on the product. It may also depend on the premium payment term or premium payment frequency that you select.

Maximum Annual Premium Criteria - It can be 2 Lakhs, 4 Lakhs, 6 Lakhs, etc. Most new age ULIPs do not have any maximum annual premium limit.

Minimum and Maximum Policy Term
Minimum Policy Term - Can be as low as 5 years or 10 years, depending on the product.
Maximum Policy Term - Can be 20-50 years or even more, depending on the product. Some products may have a maximum policy term of 99 years (Whole Life ULIPs)

Minimum Lock-In Period
When you start investing in a ULIP, a lock-in period is activated - for 5 years. So, during the initial 5 years of your policy term, you aren’t allowed to access and withdraw the fund value of your policy. You can make withdrawals after that.

Premium Payment Term
As discussed before, you can choose to pay all the premiums -

• At once (Single Pay)
• For a limited duration, say 5 years or 10 years (Limited Pay)
• Till the end of the policy term (Regular pay).

Ideally, you should pay the premiums till the end of the policy payment term to get maximum returns.

Saying that, a ULIP is a long-term investment. There might be a possibility that you want to stop your policy before it matures! You might wish to switch to a new plan, or you might not be able to pay the premiums. Whatever the reason - you should be aware of the ‘escape route’ - so you can make a financially sound decision.

So, what happens when you stop paying the premiums?

Stopping premium payment before the lock-in period is over

• The insurer will deduct the surrender/ discontinuance charges from your fund value. The remaining fund value will be shifted to a Discontinued Policy Fund.
• The insurance cover, if any, will stop immediately.

You can choose to revive or surrender your policy. If you surrender it, you receive the Discontinued Policy Fund Value - the fund value on the day of discontinuance with interest.

Stopping premium payment after the lock-in period is over
Your policy converts to a reduced paid-up policy. The Sum Assured is reduced in proportion to the number of premiums you have paid to the total number of premiums payable during the policy term.

You can choose to revive or completely withdraw your policy. If you don’t, your policy continues on a reduced paid-up basis. After the revival period ends, the insurer pays fund value and the policy terminates.

Mehak, a 35-year old female, bought a ULIP on 25th January, 2022 for a period of 20 years. She will be required to pay an annual premium of Rs 50,000. For the sake of simplicity, let’s assume Rs 5000 will be deducted from the same as charges. Hence, the investable amount per year is Rs 45,000.

She needs to take care of her son’s education and wedding expenses when she turns 55 and will require a lump sum amount for the same.

She has appointed her son, Aarav, as the policy nominee. The death benefit will provide him with sufficient cover to meet these goals as well. Her policy states that the death benefit will either be the Sum Assured or the Fund Value as on the day of her death, whichever is higher.

Let’s see how the plan works.

Maturity Benefit
Assuming that the Net Asset Value of the units was Rs 500 on the date of policy purchase,

Total units = Amount invested- Charges/Net Asset Value
= 45000/500
= 90 units.

Say she accumulates another 1710 units from the premiums she invests through the 20 year term of the policy.

So, the total units accumulated till 2041 = 90 + 1710 = 1800 units

The maturity benefit will be equal to the fund value as calculated on the date of the policy maturity.

Let’s assume that the NAV on the policy maturity date is Rs 700.

Therefore, maturity amount = NAV x Owned Units
= 700 x 1800
= 12,60,000

So, Mehak is eligible to receive Rs 12,60,000 as the policy maturity amount in 2041. The policy will terminate after the amount is paid to her.

Death Benefit
Let’s look at a scenario where Mehak passes away before the policy term.

As discussed earlier, the death benefit is higher of the sum assured or the fund value.

Let’s assume the sum assured is 10 times of the annual premium. So, in this case -

Sum Assured = 10 x Annual Premium
= 10 x 50,000
= Rs 5,00,000

The fund value is calculated on the basis of the NAV and the accumulated units.

Let’s assume that the NAV on the date of her passing away is Rs 600 and her plan accumulates an additional 910 units till the date of her death.

The total units accumulated till the date of her death = 90 + 910 = 1000 units

So, Fund Value on that date = NAV x Owned Units
= 600 x 1000
= Rs 6,00,000

Therefore, since the Fund Value is higher than the Sum Assured, her son will receive a death benefit of Rs 6,00,000.

This brings us to the end of the article. ULIPs are a little tricky and we hope this article made these concepts easy to understand. Now that you are aware of what ULIPs are, their features and benefits, charges, etc. - you can make an informed decision of whether this is the right plan for you. To gain more clarification on why you should invest in a ULIP - refer to our next article!