Nowadays, Life Insurance companies are more eager to manage your investments through unit-linked insurance plans (ULIPs). Indeed, almost 60% of new insurance sales are in ULIPs (the figure is even higher for some new private insurance companies), suggesting that things are topsy-turvy in the insurance world. So much so that a couple of insurance companies offer only ULIP plans, and no traditional insurance products. ULIP is combination of Insurance + Investment.

Many retail investors believe insurance is a part of one’s investment portfolio. Insurers capitalise on this common misconception and push investment products like ULIPs over traditional insurance products like a term policy or whole life policy. Insurance is primarily a product for protection, whereas mutual funds are ideal conduits for managing investments. So insurance should be used to insure and protect, and mutual funds should be used to create wealth over the long term.

ULIPs bundle insurance cover with an investment benefit, in a single contract. They are similar to mutual funds in terms of structure and functioning. The insurer allots units to ULIP investors in the same way as a mutual fund, and the net asset value (NAV) is declared on a daily basis. So, of the total premium you pay on a ULIP, part goes into an investment portfolio, and the rest is used to offer life cover.

A better alternative to a ULIP is a combination of low-cost term insurance and a good equity mutual fund. Term insurance provides coverage for a specified period, and is amongst the cheapest insurance products. Its no-frills design only covers your life for a fixed period. Combining it with an equity, balanced or debt mutual fund gives you the benefits of a ULIP at a much lower cost. In the end, your long-term returns are higher. Let’s come an analyse a few aspects of investing in ULIPs versus mutual funds.

Liquidity

ULIPs score low on liquidity. According to guidelines of the Insurance Regulatory and Development Authority (IRDA), ULIPs have a minimum term of five years and a minimum lockin of three years. You can make partial withdrawals after three years. The surrender value of a ULIP is low in the initial years, since the insurer deducts a large part of your premium as marketing and distribution costs. ULIPs are essentially long-term products that make sense only if your time horizon is 10 to 20 years.

Mutual fund investments, on the other hand, can be redeemed at any time, barring ELSS (equity-linked savings schemes). Exit loads, if applicable , are generally for six months to a year in equity funds. So mutual funds score substantially higher on liquidity.

Tax efficiency

ULIPs are often pitched as tax-efficient , because your investment is eligible for exemption under Section 80C of the Income Tax Act (subject to a limit of Rs 1 lakh). But investments in ELSS schemes of mutual funds are also eligible for exemption under the same section .Besides the premium, the maturity amount in ULIPs is also tax-free , irrespective of whether the investment was in a balanced or debt plan. So they do have an edge on mutual funds, as debt funds are taxed at 10% without indexation benefits, and 20% with indexation benefits. The point, though, is that if you invest in a debt plan through a ULIP, despite its tax-efficiency your post-tax returns will be low, because of high front-end costs. Debt mutual funds don’t charge such costs.

Expenses

Insurance agents get high commissions for ULIPs, and they get them in the initial years, not staggered over the term. So the insurer recovers most charges from you in the initial years, as it risks a loss if the policy lapses. Typically , insurers levy enormous selling charges, averaging more than 20% of the first year’s premium, and dropping to 10% and 7.5% in subsequent years. (And this is after investors balked when charges were as high as 65%!) Compare this with mutual funds’ fees of 2.25% on entry, uniform for all schemes. Different ULIPs have varying charges, often not made clear to investors.

But most of the Mutual Fund are offering the Free entry load. It varies from the plan to plan and company to company.