Benefits of systematic investment in ULIPs
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Market setbacks at the earlier stages of a policy will not significantly affect the yield to maturity. But any reversal in the last few years before maturity can reduce it considerably.
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The impact of economic recession on the IT sector continues to dominate the headlines. What has gone unnoticed is its impact on life insurance companies. Not only premium incomes but also the employment potential of many companies have declined.
The global meltdown and consequent erratic stock indices have shaken public confidence in long-term financial planning. There is visible reluctance to purchase an insurance policy and commit oneself to pay premiums regularly over a number of years. The Sensex, the stock market barometer, over the last 25 years, suffered massive crashes in 1992-93, 2000-01 and 2008-09 — at eight year intervals.
On earlier occasions, when the index crashed, there was no impact on the life insurance industry. Why this time? Till the opening of the insurance sector, the Life Insurance Corporation, the sole insurer, was marketing traditional products, considered symbols of stability and security, immune to the vagaries of the stock market. The new companies that came on the scene, trying to capitalise on the stock market boom, began marketing unit linked products, ignoring traditional products. The ULIPs are highly sensitive to stock market fluctuations. Consequently the life insurance industry came to be identified with the stock market and lost its image of safety and stability.
Market-related risk
Are unit linked products unsafe as seen by some? It must be admitted that though the Sensex had crashed three times, it had advanced from just 245 in March 1984 to 9700 in March 2009 (after reaching a peak of 21000 last year), an annual growth of 16 per cent. Stock market indices tend to increase steadily under the influence of economic growth and inflation. But, under the impact of speculative forces, the growth can be uneven. Investors can minimise, if not eliminate, the impact of speculative forces through systematic investment in ULIPs or mutual funds. Under a unit linked plan, the premiums are invested in equities and the value of the units on any day moves broadly in line with the stock index on that day.
Suppose a person had taken out a ten year policy on March 31, 1984 and paid Rs. 1,000 every year. Ignoring all charges and the dividend income from investments, what is the gross yield he can expect by March 1994?
Based on the changes in Sensex, the average yield will be 17.8 per cent. If the date of commencement had been March 1985 or 1986 … or 1999, the yield to maturity at the end of ten years would have varied between 4.8 per cent and 30.3 per cent. And in four of the 16 cases the yield would have been negative. The range of variation is quite wide and the chance of negative yield is 4 out of 16, or 25 per cent.
Long-term helps
The range will narrow down and chances of negative yield come down with increasing policy terms. The results will be still better with quarterly or monthly modes of premium payments. If dividend incomes from investments and the fact that fund managers invariably outperform the market index are also taken into account, the net yield after deduction of charges may exceed the gross yield.
This means that an investor in ULIPs should opt for a minimum term of 15 years and, preferably, a quarterly mode of payment. And, having chosen a plan, he should select a fund with more than 50 per cent equity content. Even if the market takes a sudden plunge after the policy is taken, be not panic and allow the policy to lapse. He should pay the next premium in time. With a lower net asset value, he can get more units for the same premium.
Market setbacks at the earlier stages of a policy will not significantly affect the yield to maturity. But any setback in the last few years before maturity can reduce it considerably.
It is therefore advised that the policy holder should start keeping a close watch on the NAV of the relevant fund and the market indices. If there are indications of a downtrend, he should surrender the policy and take out the cash value.
By following the above steps one can insulate oneself, though not fully, from market fluctuations and hope to get a better return than what one can get from a traditional product.
A lucky few may even get a very high return while the unlucky ones may end up with very low or even negative returns.
So, what should an investor go for — a traditional or unit linked product? Those who are not financially strong and cannot afford even a small loss, should opt only for a traditional product. Those who can take some loss and are keen on a high return, may put 35 per cent of his allocation in unit linked and 65 per cent in traditional products. Those with good financial strength can place up to 70 per cent in unit linked schemes.
On what basis is the above advice given and what is the difference between unit linked and traditional insurance? These will be discussed in these columns a little later.
R. RAMAKRISHNAN
Actuary
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