It’s a sham! How to spot the Ulips sold as mutual funds

Therefore, many volatile investors have been taken for a ride by advertisements promoting inappropriate financial products, including unit-linked insurance plans (Ulips). Take, for example, the case of Tushar Jejani, 24, who works as a senior financial analyst at a multinational company in Hyderabad. His bank’s relationship manager approached him about a new fund offering (NFO). Since Jejani had known the manager for a long time, he decided to invest ₹75,000 in the NFO, which he considered to be a mutual fund offering. He was asked to pay ₹75,000 per annum for the next five years.

Jajani later came to know that Ulip had been sold to him, which he had not bargained for. “It was only when I read the policy documents that I understood what the NFO really was,” said Jejani, whose money is still stuck in an insurance-cum-investment plan of the insurance bank.

To be sure, Ulips combine two products – insurance and investments. The amount of premium paid by a policyholder is divided between insurance and investments after first deducting various expenses. For example, there is a mortality charge associated with insurance. Insurers deduct all such charges from the premium before investing the balance amount in equity, debt or hybrid fund categories. So for all ₹100 paid as premium, approx ₹10 goes into insurance and other costs. The balance is invested in a Ulip fund from which fund management charges (FMC) are deducted. FMC has a limit of 1.35% of the premium amount. The policyholder can switch between the various investment funds offered by the company but cannot switch to funds offered by other companies. All Ulips offer a fixed number of switches that can be made in a year for free.

Although Ulips are not pure mutual fund products, many investors think they are. This confusion occurs when the advertisements placed by insurance companies are loaded with terms generally associated with mutual funds. For example, when a leading life insurance company launched a Ulip some time ago, it was positioned as a ‘new fund offering’ and mentioned terms like ‘net asset value’ (NAV). This made the Ulip look like a mutual fund offering. Another insurer’s Ulip advertisement also spoke volumes about Ulip fund schemes. In both cases, the word ‘insurance’ was not used and the reference to ‘life cover’ was hidden in the fine print.

Inquiries sent to the Advertising Standards Council of India and market regulator Sebi on whether such ads violate any rules did not elicit results.

“There are no restrictions within the framework for insurance companies to introduce NFOs at specific NAVs in the context of Ulips and combination plans. A regulatory conflict between insurance regulator Irdai and Sebi over Ulips and hybrid products with an equity component was resolved through an amendment in 2010, but many issues relating to investor and policyholder protection remain unresolved. Today, when a conglomerate has arms of insurance and mutual funds, its advertisements can create confusion for investors, especially if they are not familiar with legal and financial terminology,” said Sumit Agrawal, founder, Legal Advisors Regstreet, and ex-Sebi. officer.

“To avoid any ambiguity, it helps if insurers use a distinct nomenclature and explanatory text to highlight that the product is a unit-linked insurance plan,” said Nirav Karkera, head of research at Fisdom.

The caveats

Initially, Ulips come with different maturities but have a mandatory lock-in period of five years. This means you can’t access the funds for five years after you buy it. If the policyholder stops paying the premiums, the amount accumulated so far is transferred into a ‘retirement fund’, which pays interest on a par with a bank savings account and cannot be accessed until the lock-in period ends in. The life cover offered by the insurer as part of the Ulip also lapses when the subscriber stops paying the premium. As for mutual funds, investors can exit these at any time by paying the applicable capital gains tax and exit load, if any.

The reason why many investors prefer mutual funds or fixed deposits is that these financial instruments allow for easy exits. Ask Bhupendra Patil, a resident of Gandhinagar, Gujarat, who retired last year at the age of 58. Patil got a lump sum of ₹55 lakh by order of pension payment immediately after retirement. He decided to put this in a fixed deposit. When he visited his bank branch, the officials convinced him to buy a unit-linked pension product. Patil realized the consequences of this when he went to withdraw money to pay for his 27-year-old son’s college admission at Algoma University, Canada. There was no way he could withdraw his money from the pension product for five years. Left with no choice, he had to borrow it ₹20 lakh from another bank.

“In Ulips, you cannot refuse the annual premium payments despite any unforeseen event and there is a penalty if you miss payments, but you have no such restrictions for SIP with a mutual fund,” said Nitin Balachandani, who runs Insurance Angels, a company that deals with claims His company helps people who have been missold insurance policies get their money back, for a fee.

The pros and cons

Ulips have other disadvantages. Many financial experts have pointed out that he lacks adequate insurance coverage. For example, the amount of life cover in Ulips is usually 10-25 times the premium paid. So if you invest ₹1.2 lakh per annum in a Ulip of an insurance firm, you will get lifetime cover of it ₹12 lakhs.

Nisha Sanghavi, certified financial planner and co-founder of Promore Fintech, recommends that life cover should be at least 10 times the annual income earned by an individual. In this case, for someone who is shelling out ₹1.2 lakh as annual premium, life cover of ₹12 lakh is not enough. A term insurance policy would be the most suitable product for an investor looking for better insurance coverage. For this, you can benefit from a lifetime cover of approx ₹1 crore paying ₹700-800 per month.

An important thing to note is that if the value of the investment increases more than the Ulip sum assured at maturity, most insurers do not pay the sum assured separately. That is because the policies come with a clause stating that the maximum insurance payout is the sum assured which includes the value of the investment. For example, if the value of a Ulip fund grows to ₹11.5 lakh, more than the amount declared ₹10 lakh, you will get direct Ulip fund value. So instead ₹21.5 lakh, you will be entitled directly ₹11.5 lakhs.

Ulips have one advantage though. Returns generated from Ulips are tax free and you can claim deduction while filing income tax. For Ulips purchased after February 2021 and where the premium is more than ₹2.5 lakh per annum, capital gains tax is applicable. For the vast majority of people who pay less than ₹2.5 lakh per annum in premiums, it is tax free.

In mutual funds, investors must pay the applicable short-term and long-term capital gains tax upon exit and cannot claim deductions while filing income tax. The exception is in ELSS (equity linked savings scheme) tax saving funds where you can claim tax deductions under section 80C but there is a minimum lock-in period of 3 years and capital gains tax is still applicable.

What do experts recommend?

Most insurance experts advise their clients to get term insurance separately and then buy other investment products of their choice, such as mutual funds, fixed deposits, national pension scheme, etc, for better returns towards their financial goals to achieve. This is because buying a specific term plan will provide more coverage than what Ulips offer. There is more flexibility in choosing the funds you want to invest in, rather than the option of easy exits.

“Insurance should not be confused with investment. Ulips usually provide 10 times the annual premium as life cover. So if one is earning ₹10 lakh per annum, the rule of thumb is to have 10-15 times the annual income as life cover. However, with a Ulip, people need to pay their entire annual income towards the premium,” said Abhishek Kumar, registered investment advisor and founder of Sahaj Money, a financial planning firm.

Kumar also said that one should not be swayed by the NAV of Ulip funds as the insurer withdraws the units for various charges like policy administration, mortality charges, etc. an attractive choice.

Remember, there is a mandatory five-year lock-in for Ulips and there is a penalty if you don’t pay your premiums on time. When term insurance is purchased separately, beneficiaries can claim the sum insured and the investment value after the policyholder’s demise. With Ulips, you only get the sum assured or the value of the investment if it exceeds the sum assured.

Sanghavi, however, said that individuals with a medical history should stick to their Ulip plans as the premium for term plans may be higher.

“One of my clients has a higher BMI (body mass index), so she was quoted a higher insurance plan than what others are offered,” said Sanghavi.