Why ULIPs are not good for your financial health... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Why ULIPs are not good for your financial health... 

A  A  A
In this issue:
» Is the Fed fooling everyone?
» One third of the US lives in debt
» Will the government meet FY15 disinvestment target?
» JSW Steel entangled in a brand promotion payment spat
» ...and more!



00:00
 
Our dislike for Unit Linked Insurance Plans (ULIPs) is well known. Time and again we have highlighted why we are not fascinated by this bundled product which offers dual benefits of insurance and investment. And when recently we came across an article from one senior executive of a private Life Insurance Company propagating ULIPs, we thought it was an opportune time for us to re-iterate our stance on them.

Well, the primary reason why people get attracted to such products in first place, is because of the twin benefit which is on offer. Plus, investment in ULIPs also presents income tax benefits to investors. Further, the bancassurance channel gave an easy platform to ULIPs. For the want of commissions they were pushed aggressively through the banking channel.

However, when it comes to performance they have failed miserably. For one, their return was linked to market performance. And this factor was camouflaged when hard selling to a policy holder. So, when share markets were in a downturn, many policyholders lost their net worth. And that too in insurance cum investment plan which is supposedly safe! Not to mention the host of charges that further ate away investor returns.

Amidst huge losses, investors fled ULIPs. Since then, IRDA made rampant changes in the product proposition. It capped charges on them since September 2010. Even the fund management expenses had a fee cap. This was done to make the product more appealing.

So, with regulatory changes having being made, should one invest in ULIPs?

Well, investors need to know that charges were not the only factor that led to downfall of ULIPs. The primary reason why ULIPs failed is because they combined both insurance and investment needs of a participant. And investors failed to understand the nature of the product. For instance, the premium one pays includes mortality charges for providing protection. The balance is invested in stock markets. This not only raised ambiguity around the product but also led to a fall in fund value when stock markets fell.

And when investors saw their fund value declining in an insurance plan, they redeemed in fear as they were unaware of such eventuality. High charges further erased their capital. With charges now being regulated, investors can draw some respite. However, the market risk will still prevail.

Also, since these products are not tailor made, there is a scope of huge mis-selling. A 70 year individual can get exposed to equity risk by buying ULIPs which is undesirable at his age! The bottomline is that both insurance and investment needs are separate. We have highlighted this innumerable times. You cannot have a one size fits all policy here. These needs depend upon individual client circumstances.

Hence, no matter what changes are being made to make the product more appealing, investors should be careful. They should keep in mind that lowering fund charges does not eliminate market risk which is inherent nature of this product.

Have you ever made money by investing in ULIPs? If yes, were you completely aware about the risks before investing? Let us know in the Equitymaster Club or share your comments below.

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01:50  Chart of the day
 
One of the key highlight of the Budget was the ambitious fiscal deficit target of around 3% of GDP by FY17. What gives the Government the confidence to achieve these targets is the big divestment program. Once again, the much exploited public sector firms are expected to bring Government's finances back in order.

There is nothing new in the new announcements of ambitious disinvestment targets. What is noteworthy is that the Government in the past has consistently failed to meet this target. However, this time, the optimism is high, backed by bullish market sentiments. The target has been set to raise amount worth Rs 584 bn in FY15, up 270% when compared to amount raised in FY14. However, despite bullish market sentiments, there are a lot of issues that could jeopardize the Government's plans. The biggest risk to the same comes from market risk. The target has been set keeping in mind the valuations that the stocks of potential disinvestment candidates have been fetching in recent times. However, in case there is a downturn, it could lead to substantial underachievement as far as funds raised are concerned. In the worst case, poor market sentiments may shelve disinvestment plans altogether.

And even if the worst does not come true, are conditions really ripe for the disinvestment plan? We don't think so. At least not from the investors' point of view. Consider this. Some of the biggest companies on the disinvestment list are still grappling with the regulatory uncertainties. A case in point is ONGC. The company has been the worst victim of regulated fuel pricing and ado subsidy sharing mechanism. Unless these issues are resolved, the real value of these companies can never be unlocked. Secondly, already four months have passed in the current fiscal year. So the Government has a window of around six - seven months to act. As an article in Business Standard suggests, raising an average of around Rs 97 bn per month will not be an easy task. That said, the road to disinvestment seems smoother than ever. Whether the Government can reach there or not is something time will tell.

Will Government meet FY15 disinvestment target?


02:25
 
The one word the US Fed has been using most frequently these days is the word 'Exit' we believe. Its monetary policy cannot stay the way it is. One day it will certainly have to start raising rates and also totally exit the quantitative easing. However, an article on a leading portal has asked what we believe is a very pertinent question. The question is about what after all would an ideal 'Exit' look like? Well, the ideal exit would be the one where the savers would no longer be punished for saving their hard earned money. In other words, an ideal exit would be the one where the real interest rates once again go into the positive.

However, don't count on the arrival of such a period any time soon, warns the author. Simply because positive real rates of interest would dramatically increase the debt burden of the US Government. And no Government would wish such an outcome during their reign we believe. Besides, the ones who suffer the most from negative real interest rates are the holders of the debt. And since US debt holders themselves are not exerting any pressure for interest rates to rise, real rates are not going to rise anytime soon. Is it any wonder then that gold should be one's preferred investment in an era where one's purchasing power is likely to keep going down for a long time to come.

02:45
 
Indian banks are crying hoarse over the NPA problem! And why not? With gross NPAs and restructured assets totalling to 9% of outstanding loans, the bad credit is nearly at a decade high. But if one were to compare the problem in India with that in credit infatuated Western economies it would be a huge relief! Take the case of US for instance. It is a known fact that credit to GDP ratio far exceeds 100% for the US, while the ratio is below 80% for India. In fact even loans to students are a big NPA problem in the US. Therefore it came as no surprise to us that one out of every three American has been defaulting in loan servicing. As reported by CNN, most of the loans are still in 'collection', hence not written off as NPAs. Steep college fees have brought the student loans to bubble territory. Further the bad credit profile, in some cases is even costing people their jobs. It may not be wrong to say that the debt problem could lead to a social upheaval in the US. Something that Indian households, with a traditionally high savings rate are not acquainted with.

03:10
 
The trend of conglomerates paying up for the usage of brand names is not very new in India. But it is one which is not widely implemented yet. Latest addition to this list is the 'JSW' brand. As reported by the Business Standard, JSW Steel's promoters have proposed to pay a particular private firm a sum equal to about 0.25% of company's revenues. Such a small percentage would turn out to be a whopping Rs 1.25 bn per annum, which would be paid to Mrs. Jindal (wife of JSW Steel Chairman and promoter Mr. Sajjan Jindal), who holds almost the entire stake in the said private firm that is believed to be the owner of the 'JSW' brand name. As obvious as it may be, this move has not gone down well with certain corporate governance experts, claiming the brand has developed over many years and cannot all of a sudden be a private property of promoters. JSW Steel is seeking shareholders' approval for this move.

It may be noted that this is a model that has been taken up by the Tatas, Godrej, and Wadia groups as well. While there may be cases wherein some brands can justify such a move, there are definitely some that cannot. At the end of the day, minority investors have the flexibility to decide whether they want to be part of such a story or not.

03:45
 
India's Union Budgets have been having one trademark feature of late. Finance ministers have been quick to announce substantial increases in plan outlays during the budget. However, actual spending on these fronts has often fallen woefully short. In fact, so much so that the increase in actual spending has been no where even close to the increments announced in the budget. And this usually stems from individual ministries' inability to efficiently spend the allocated funds to them. Further, the biggest victim to this ends up being the spending that happens on investments and other such capital spending. Spending on populist avenues hardly falters much. Sadly, it is the former which sets the stage for sustainable growth of the economy. It is perhaps time that the finance minister has much greater emphasis on efficient spending of the funds allocated in the budget, especially capital spending.

04:15
 
In the meanwhile, the Indian stock markets have extended losses in the afternoon trading session and have slipped into the red. At the time of writing, BSE-Sensex was trading lower by 118 points (-0.5%). While consumer durables, FMCG, Banks and healthcare were trading in green, most of the other sectoral indices were trading in the red with capital goods and metals being the major losers. Asian indices were trading mixed with Taiwan and Hong Kong being major gainers, whereas India and Singapore were trading weak. European markets opened the day on a weak note.

04:50  Today's investing mantra
"Our approach is very much profiting from lack of change rather than from change. With Wrigley chewing gum, it's lack of change that appeals to me. I don't think it is going to be hurt by the Internet. That's the kind of business I like." - Warren Buffett
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11 Responses to "Why ULIPs are not good for your financial health..."

harish kumar

Dec 1, 2014

My first job when i was just out of college was in a leading private sector bank whose stock prices is soaring 30% year on year and when i analysed the business main reason i got, is insurance. The cluster heads, regional heads and all are so concerned about insurance because it gives immediate profit of 14% to the branch and it helps in achieving the break-even point for the branches, since all branches are under the preview of the cluster head and branch heads and their ratings and performance is highly determined by how quickly one can achieve the magic number(break-even). Since greed and personal interests overtakes ethics and moral these cluster heads and branch heads insists on miss-selling the so called ULIPs at the expense of trust and customer benefits. Adding salt to the injury the so called RMs are miss-selling these junk product to the customers without even the basic knowledge of banking and insurance. So the bottom line is ask some tough questions to the RM when they call you next time for an insurance or mutual fund. I noticed how they are miss-selling the junk to a less educated customer by explaining that they are going to put their money in fixed income products, which are solid and risk-free. The main concern is these sectors are all driven by sales and not by intellectuals, trust,ethics or goodwill. I can even guarantee that the branch heads and the cluster heads are also so dumb, that if you ask the simplest of simple question of finance and banking they cannot answer it. Only Greed drives them to achieve their so called success. The corporate culture is so bad that it forced me to quit the job within one year.

Like (3)

Krishna

Aug 4, 2014

I agree, Ulips are not a great way to invest and grow wealth. In fact I would say that many of the Non-Ulip insurances are also not really wealth creators as they are touted to be. We have to choose carefully.

My firm belief is that Insurance & Wealth creation have completely different objectives and should not be confused.

Insurance should be taken for Pure Risk coverage and therefore I am a great fan of Term Insurance.

For serious savings, Mutual fund and Equities are better. There is some merit in taking insurance endowment plans mainly to reduce risk and get tax fee normal returns as compared to an FD. Otherwise most Endowment policies give FD like returns only but there is no tax on the gains unlike FD.

So better to approach - Insurance and wealth creation - as 2 separate endeavours and not confuse them with wealth creation by getting fooled with ULIPs and Endowment.

Like (3)

Rekha K

Aug 1, 2014

I had an investment portfolio with HSBC with whom I had my salary account 8 yrs ago.. Their Rep would come home and used to suggest and I followed it hoping it would be better than money lying in bank.. in 2 yrs I put money in 10-12 mutual funds and made average of 25% in 1.5 yrs.. then they suggested ULIP (canara-HSBC 60 yr term Ulip plan) since it was 100% equity I went ahead with it..5 yrs completed this july (@ 2.4 lk premium each yr).. as of today it is showing 25% gain but this is after 5 yrs of putting in money averaging 5-6% per annum.. maybe now that market is in bull phase it may go up for a year or two.. i am not sure whether to exit now or after 2 yrs..I stopped working 6 yrs ago..my husband has his insurance hence i don't need since i'm not working

Like (4)

Ravi

Jul 31, 2014

I also invested in an ULIP. However, since I paid premiums over a 3 year period, it was effectively like a 3 year SIP and so I got the benefits like any normal SIP. I am aware that the charges are significant and eat into the profits made on the investments. Can you please clarify two points:

1) Are the caps applied by IRDA since Sep 2010 applicable also for ULIPs bought before Sep 2010?

2) What specifically are the caps on charges and fees?

Like (3)

SUBRAMANIAM NATRAJ

Jul 31, 2014

It is very informative on the latest happenings
on the financial front, economy and government's
future plans to improve the economic recovery.

Like (3)

rajeev mathur

Jul 31, 2014

another fact about ULIPS which you have not mentioned is purchase of annuity on maturity. the investors purchase annuity for regular income. however, one gets only 6-7 % return on the corpus and this is taxable. i have purchased several ULIPS but shall redeem them as soon as the policies become free of surrender charges and shall invest the funds elsewhere.

Like (3)

Venkatesh Rao

Jul 30, 2014

ULIPS were a ripoff and broad daylight robbery in the first place. HOw could the wise men in IRDA alow these products with such high administrative charges in the first place.
To corect this wrong IRDA should ask these Insurance companies to retrospectively compensate pre 2010 gullible investors. This is the least they can do.
The Govt. passes retropsective tax amendments bill with alacrity , but does nothiing to punish mis selling by imposing punitive charges.

Like (5)

Hassan

Jul 30, 2014

I invested in BSLI ulip 25,000 for 4 yrs,
When I closed it in the 5th year I got only 70,000.
That ulip underperformed.

Like (3)

H K Prakash

Jul 30, 2014

I recovered my money in XYZ's ULIP after I paid 3 annual installments = 6 for 2 daughters, and stopped and even after that there was a premature withdrawal charge (for not keeping it for 5 years!)
The problem is even now there is a 10% charge on the first installment to pay commission to the agent. So if you know about time value, this hits return the hardest
After that the MF pays lakhs to the experts hired to invest the money. (If they just put it in index tracker MFs instead, they would have done better)
There is not much alternative as term insurance is NOT available to a father like me trying to insure his unmarried daughter
I paid in 48,000 X 6 and got back these sums plus a small profit of Rs 200 as the market took off recently taking XYZ's conservative MF up from R18 to R21!
People in the "dark areas" of the North have many daughters in their quest for a son. The problem is what to do with the 3/4/5 daughters? An agent approaches the dad and whispers dark things. The dad buys a term insur. in his eldest d's name costing Rs 7500. The agent knows a goonda who will kidnap the d., enjoy her company for a few days THEN throw her in front of a speeding truck. The grieving dad, agent and goonda share the Rs 50 lakhs.
So, as a father, I cant buy the cheapest vanilla term insurance for my d. as I might do the same as that beastly father in the North! (this is called MORAL HAZARD by the industry)

Like (5)

V.S.Patil

Jul 30, 2014

Yes, I had invested in ULIPs with full knowledge about their nature, risk factors involved and also advantages and disadvantages. The Plans are a combination of insurance and investment aspects. These plans were launched when the Stock Market was booming and people were eager to take its benefit but were not adequately equipped with proper knowledge. Insurance companies took advantage of the occasion and brought out ULIPs. You are right when you say that the said ULIP plans are not suitable for everyone and risk involved should be appreciated by the investor-cum insured which was not the case in most of the cases.The performance of the ULIP is solely dependent on the performance of the stock market. Unfortunately market did not perform to the satisfaction of the investors and as such many ULIP holder had to burn their fingers.There were many instances of what you have mentioned as mis-selling without proper understanding the nature, structure and terms and conditions etc., of the said plans I for one though did not make profit worth the name, got even with my investment.Stock Market performance is the sole factor in ULIPs and as such risk of investment runs very high. If one is lucky, the market would boom and one would make profit otherwise some may not get even what they have invested. There are a number of charges which are recovered by the insurer which again makes a dent in their yield. NAV is declared on the basis the performance of the fund opted by the investor. In short, the insurer makes investment on behalf of and as per the direction of the and investor and as such the risk therein is the sole responsibility of the investor. Investor gains if the Market gains otherwise not.As far as insurance element is concerned it is paid as per the risk insured against and usually it is death benefit if unfortunately the insured dies while the policy is in force.

Like (3)
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