ULIPs, charges named

A unit-linked insurance plan invests your premium in funds you choose, deducts charges, and provides life cover. It is a mutual fund inside an insurance contract, and the question is always what the wrapper costs.

The charges, by name

The actuarial pricing requirements name them, and they appear on your statement:

Premium allocation charge — deducted from each premium before anything is invested. A 5% allocation charge means ₹95 of every ₹100 reaches the fund.

Mortality charge — the cost of the life cover, deducted periodically. It rises with your age, because the risk does.

Fund management charge — an annual percentage of the fund value, like a mutual fund's expense ratio.

Policy administration charge — a flat or escalating amount for running the contract.

Discontinuance charge — applied if you stop paying during the lock-in.

Switching and partial withdrawal charges — often with some free switches a year.

The structure is the thing to notice. Several of these are taken off the top before investment, and they are front-loaded. A mutual fund's cost is one annual percentage of assets; a ULIP's is a stack, some of it deducted before your money ever reaches a fund.

Lock-in and discontinuance

ULIPs carry a five-year lock-in, and the rules on stopping are specific.

If you stop paying during the lock-in, the fund value less applicable discontinuance charges is moved to a discontinued policy fund, and the risk cover and rider cover cease. Those discontinuance charges are capped by the regulations rather than left to the insurer.

You get a revival period of three years from the date of first unpaid premium. At the end of the lock-in, the proceeds of the discontinued policy fund are paid to you.

Two consequences worth stating plainly. You stop being insured the moment the policy is discontinued — the protection goes before the money does. And the money is unavailable until the five-year lock-in ends regardless of when you stopped paying.

The document you are owed

This is the most useful fact in the subject, and it is the reason this chapter exists.

IRDAI requires a customized benefit illustration at the point of sale. Its requirements:

At the point of sale, a benefit illustration shall be shown as per the gross investment returns ... currently the gross investment returns are stipulated as 4% p.a. and 8% p.a. The corresponding net yield shall be demonstrated only with respect to gross investment return as stipulated by the Competent Authority. Currently such rate is 8% p.a.

The customized benefit illustration shall include all charges and taxes as applicable, and fund values including commission or remuneration payable.

The net yield and hence reduction in net yield as calculated, shall be disclosed in the benefit illustration indicating gross yield figures.

Read what that gives you. The seller must hand you a document that:

• assumes the fund earns 8% gross
• subtracts every charge, including the commission being paid to the person selling it to you
• states the net yield you would actually receive
• and states the reduction in net yield — the gap between the two

That gap is the cost of the product, quantified by the regulator's own formula, disclosed before you sign. It is the single number that answers "what does this cost me", and it is legally required to be in your hands.

It is also, in practice, a page people sign without reading, usually at the end of a long conversation about the maturity value.

How to use it

Find the reduction in net yield. If gross is 8% and net is 5.6%, the product costs you 2.4 percentage points a year, every year.

Compare that with the alternative. An index fund's expense ratio is a fraction of a percent, and term cover bought separately has a known annual premium. If the ULIP costs 2.4 points a year, ask what you are getting for it that term plus an index fund does not give.

Check the first-year figures separately. Because charges are front-loaded, the reduction in yield over five years can look very different from the figure over the full term. A product quoted on a twenty-year illustration may be far worse if you exit at year seven.

Treat the 8% as an assumption, not a forecast. The regulator stipulates it so that products are comparable, not because anybody is promising it. The illustration at 4% is the more sobering document and it is required to be shown too.

Where ULIPs are defensible

Not never — and the honest cases are narrow:

You want the lock-in. Five years of enforced investing, with cover attached, is a commitment device, and Designing around yourself takes that seriously as a real benefit for someone who would otherwise stop.

Tax treatment, read currently. Chapter 7 covers this, and the conditions have tightened.

Switching between debt and equity inside the wrapper without a taxable event, which is a genuine structural feature.

None of those is a reason to accept an unquantified cost, which is why the benefit illustration comes first.

Working the problem

Being sold a ULIP.

The document to demand: the customized benefit illustration. It is mandatory at the point of sale, not a courtesy, and the seller is required to produce it including all charges and taxes and the commission payable to them.

The figure that answers the question: the reduction in net yield. Not the projected maturity value, which is the number the conversation will be built around and which tells you nothing without the rate attached. Not the sum assured. The gap between the stipulated 8% gross and the net yield after all charges.

What I would do with it:

1. Read it as an annual cost. A reduction of 2.4 points means the product consumes 2.4% of the fund every year, compounding. Over twenty years that is a very large share of the final amount.

2. Compare like with like. Price term cover for the sum assured separately, then an index fund for the remaining premium. If term costs ₹15,000 and the fund charges 0.2%, the honest comparison is: does the ULIP's convenience, lock-in and tax treatment justify roughly two points a year?

3. Look at the 4% illustration too. If the product only works at 8% gross, it is relying on an assumption you are not entitled to.

4. Check the exit arithmetic at year five and year seven, not only at maturity, because that is when most policies actually end.

5. If the seller cannot produce the illustration, stop. The requirement is on them. An unwillingness to show the reduction in yield is itself the answer, and chapter 9 of Ethics and regulation explains why that is more than a service failure — not taking reasonable care to ensure suitability is a defined limb of mis-selling, and so is concealing material facts.

And remember the thirty days. If you have already signed, the free look period lets you cancel after reading the illustration properly. That window exists precisely for this situation.

The point

A ULIP is a fund inside an insurance contract, and its cost is a stack of named charges — premium allocation, mortality, fund management, policy administration, discontinuance — several deducted before your money reaches a fund. It locks in for five years, and stopping during that period ends the risk cover immediately while the money stays until the lock-in expires, with a three-year revival window. IRDAI requires the seller to hand you a benefit illustration at the point of sale, computed at 4% and 8% gross, including all charges and the commission payable to them, disclosing the net yield and the reduction in net yield. That reduction is the price of the product, and it is the only figure worth negotiating over.