When drawing similes, it’s just like combining the user experience of a tablet with the amazing computing prowess of a laptop in a two-in-one laptop! The tulips of ULIP provide the fragrance and colour both of insurance and investment. On the other hand, the term insurance plan is a life insurance plan for a fixed term.
What is ULIP?
Unit Linked Insurance Plan or ULIP is the most significant and sought-after departure from the traditional insurance plans. It is a smart combination of different investment options with an insurance plan.
Thus, the idea is to get a specified amount from the investor-cum-insurer. Out of this amount, a specified amount goes for an insurance plan with designated returns and the remaining amount is invested in the market. This way, over a period, a specified number of units get accrued, and the rate of return is much higher than a traditional insurance plan like term insurance plan.
What is Term Insurance?
Before we understand the basic difference between a ULIP and a traditional Term Insurance, it is important to get updated with what term insurance is all about. Term insurance is life insurance for a specified period called “term.”
This term is a fixed number of years as laid down in the policy. If the term policyholder dies before the end of the term, his/ her beneficiaries get the death benefit. These term insurance policies come with many add-ons like accidental death cover, critical illness cover, etc.
Mechanism of ULIP plans
Unit-linked Insurance Plans follow a simple “investosurance” mechanism.
There is a pre-defined premium amount that the insurer pays.
This premium payment can be monthly or annually as decided regarding the ULIP.
The premium is further divided into units for investment and mortality charges (that is premium for insurance cover).
The investment pattern as to the choice of assets invested in may vary from person to person.
Under Unit-linked Insurance Plans, there is a specific lock-in period (usually five years) post which one can withdraw from the fund.
The investment returns (profits earned on units invested) from ULIP are free from tax burdens.
The rate of return has a fixed component attributed to the insurance part and a variable component attributed to the investment part.
Thus, under a Unit-linked Insurance Plan, one can look forward to the protection of monies via savings as well as lots of earning possibilities through investments.
A unit linked Insurance Plan is subject to various charges.
Kinds of ULIPs vis a vis term insurance
Though ULIPs can be dependent on a host of factors like the insurance company involved, the advisor’s knack of extracting the best option for the insurer-cum-investor, etc., the real determining factor is the risk appetite of the investor. This is mainly because unlike term insurance; a ULIP acts like a mutual fund with life cover or term cover.
While term insurance plans mainly focus on the sum assured, ULIP focuses mostly on the rate of returns. The sum assured can increase or decrease or remain constant under different types of term insurance plans. Some plans come with the benefit of return of premium paid if the insured survives the term. The insured searches for more riders in the form of the accidental death benefit, critical illness cover, etc.
On the other hand, based on the risk appetite of the investor-cum-insured, a ULIP can be classified as:
Equity funds: These are Unit Linked Insurance Plans which mainly invest in stock and equity. These have high risks attached.
Interest or debt funds: Here, the units are invested in fixed assets like bonds, debentures, etc. These have medium to low risks involved.
Cash funds: Here the units are invested in a money market that is instrumented with high liquidity like Treasury Bills, Commercial Papers, etc. These have the lowest risks involved.
Balanced funds: These are investments in a combination of equity and debts, and hence the risk involved is medium.
Difference between a ULIP and Term Insurance
ULIP and term insurance can be differentiated on the following parameters:
While Term Insurance only provides for pure, organic insurance, ULIP is all about combining insurance with investment. So, part of the premium is used to pay mortality charges which are the insurance component of the plan, and the other part is used to buy units of different companies to get investment returns.
There is no lock-in period in term insurance. It must be renewed every year. There is no provision of withdrawals except for different riders attached. On the other hand, in case of a Unit-linked Insurance Plan, there is a specified lock-in period, usually 3 or 5 years. Beyond this lock-in period, withdrawals can be made from the fund.
There is no investment element in term insurance. In case of a Unit-linked Insurance Plan, part of the premium paid is used for investing in units of companies (like equity, debt, bonds, money market, instruments, etc.) to get returns just like mutual funds.
The beauty of a Unit-linked Insurance Plan lies in its switching option. Based on prevalent market conditions, the fund manager or advisor can advise the insurer-cum-investor on the most lucrative yet low-risk investment option.
Based on this assessment, the insurer-cum-investor can choose to switch from the fund to fund to maximize his/ her returns while trying to keep his risks on the lower side.
Most plans come with an annual cap on the number of switches that can be made without incurring any charges.
On the other hand, traditional term insurance has no scope of investment or switching over from one investment to the other.
Term insurance promises of a specified maturity amount at the end of the term. This is called the sum assured. Together with this, he/ she may get bonuses, if any, that have accrued under the plan.
However, in case of a Unit-linked Insurance Plan, the maturity amount is the redemption of units on the market value of the units that are prevalent on the date of redemption.
There are no charges except for premium payment in case of term insurance. However, in a Unit-linked Insurance Plan, there are many charges involved. These include:
Fund management fees for managing the funds,
Policy administration charges for execution of the plan,
Mortality charges for payment of insurance premium,
Surrender charges for partial or full encashment of the units before the maturity date,
Fund switching charges for switching on to different units for investment beyond a specific number of free switches,
Premium allocation and a host of other charges.
Security wise, the most secure option will anyway be the one with 100% insurance and no investment. So, term insurance is the most secure option. But in the case of a Unit-linked Insurance Plan, there is some amount of risk attached depending on the kind of assets invested into.
Where the assets invested into are the stock and equity, the risk involved is the highest.
In case the units invested upon are the debts and debentures of companies, the risk involved is medium to low.
In case the units invested upon are the money market instruments, the risk involved is the lowest.
In case of balanced investment into a variety of options like equity as well as debt options, the risk involved is medium.
Rate of return
In case of a plane jane term insurance, the return is the sum assured which is a fixed amount.
A Unit-linked Insurance Plan, on the other hand, has investment elements. Hence it gives varied rates of return. The rate of return is always in direct proportion to the risk involved. So, the higher the risk involved, the higher is the rate of return and vice versa.
So, ULIPs with investment in equity will yield the highest returns!
Both term insurance plans and Unit-linked Insurance Plans offer tax deduction under Section 80C of the Income Tax Act. In the case of term insurance, there is added the benefit of the sum assured being tax-free.
How to choose between ULIP and Term Insurance
For heavy insurance coverage, term insurance is the best option. However, different focus areas are depending on the age, risk profile, the sums that a person can invest that will determine his/ her preference to take up term insurance or a ULIP. Another governing factor is the charges involved in a Unit-linked Insurance Plan. One must do proper reiki of the charges and see the rate of returns that various units offer to arrive at a clear-cut conclusion as to the option to go for.
All in all, the middle path is always the best path. Going by this ideology, a plan with savings, protection, and returns is something which anyone will opt for. ULIP qualifies into this category of a better rate of returns than term insurance. It combines the stability of traditional insurance with a high rate of returns of mutual funds under one umbrella and is the most sought-after insurance-cum-investment option.