An introduction to ULIPs


With LTCG tax being levied on equity investments made either through mutual funds or direct trading, there is renewed interest in ULIPs as these do not attract LTCG tax (as per current tax laws). So, what is an ULIP and how does it work?

What is an ULIP?
An Unit linked insurance Plan (ULIP) is a Life Insurance product combining life insurance and investments in a single product. You would say a traditional plan does the same, however unlike traditional policies where investments are made in debt instruments, the ULIP allows the policyholder to participate in the capital markets by allowing investments in debt and equity instruments. Also, it offers the flexibility to switch from debt to equity or vice versa, thus providing more control and freedom in the hands of the policyholder.

How does an ULIP work?
Rahul, a 30-year-old has purchased an ULIP plan. He pays an initial premium of Rs 50,000/-. The ULIP premium is split into two parts i.e charges and investible amount. The charges are bifurcated into upfront charges and monthly charges. 

For Rahul, the allocation would be as under:

Premium paid
50,000
Less: Upfront charges
  4,500
Investible Amount
45,000

Being an ULIP, Rahul has an option to choose where this amount of Rs 45,000/- is to be invested. To accommodate various risk appetites, every insurer offers a variety of three basic types of funds which are:

Debt:
The investments are done in a mix of debt or fixed income securities such as government securities, money market instruments and corporate bonds. There is low risk as compared to equities. A low risk also entails conservative or low returns.

Equity:
The investments are primarily done in the equity markets. The risk is very high and so is the potential for higher returns.

Balanced:
This is aimed at people who have a moderate risk appetite and wish to earn more returns than what a debt funds offers but are averse to the high risk of equities. These funds are a combination of debt and equity funds.

Let’s assume that Rahul has chosen the Equity fund. The amount meant for investments (Rs 45,000/-) would be used to purchase units of the equity fund at the prevailing NAV. Let’s consider the NAV to be Rs 10/-. The NAV is the price of a single unit of the chosen fund. Thus, Rahul would be allotted 45000/10 i.e. 4500 units.

The below table depicts the allocation details:

Investible amount (Rs)
NAV (Rs)
No. of units
45,000/-
10
4500

The NAV changes every business day and accordingly the value of the units will vary. The value of the units is known as the policy fund value (NAV*units). Every month on a pre-determined day (mostly the monthly date coinciding with the issue date, if the policy issue date is 25th Nov, so 25th of every month) the monthly charges are deducted from the policy fund value by cancelling units at the prevailing NAV.

When Rahul pays a renewal premium, the process explained above is repeated. The total no. of units increases when premiums are paid and subsequently reduces when units are deducted to pay for monthly charges or in case of cash withdrawal, policy surrender etc.

So, this is how the premium allocation works in a ULIP policy. We have been talking about charges above, what are these charges? We’ll see that in the next post. Happy reading!!

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