Single premium unit-linked insurance plans (Ulips) have gained popularity ever since Ulips faced a regulatory whip on the product and cost structure. However, do they work for you? The answer is no. As investment products, they yield lower than regular premium policies and as insurance they offer very little cover. Also, after the Finance Bill is implemented, the returns from single premium Ulips will take a further hit.
As an investment tool
Costs: From the one-time premium you pay in a single premium policy, four kinds of costs get deducted: policy allocation charge, which is a straight deduction from your premium, policy administration charge, mortality charge and fund management charge; the last three are usually deducted from the fund value.
Policy allocation charge is a one-time charge but the remaining three are usually an annual cost. Says N. Varadarajan, executive director, Edventus Business Enhancers Pvt. Ltd, a human capital management firm: “Policy allocation charge is a one-time charge in single premium policies and may appear less in percentage terms than what regular premium allocation charges are, but it is levied on a larger upfront amount. Other charges such as policy administration and fund management charges are recurring and are levied regularly. These charges are similar in both single premium and regular premium policies for comparable sums assured.”
Low rate of return: What then causes a single premium policy to yield a lower rate of return? The answer is recurring cost from the same pool of funds.
Says Anand Pejawar, executive director (marketing), SBI Life Insurance Co. Ltd: “Single premium Ulips will give you a lower net rate of return when compared with regular premium policies. That’s because in case of a single premium policy, the insurer has a limited pool of funds to deduct all charges and mortality expenses from. On the other hand, in case of a regular premium with constant inflow of premiums at regular intervals, the customer will get the benefit of rupee-cost averaging.”
But this comparison is true for any regular investment product and lump sum product. In a single premium Ulip, the difference in returns is also due to the mortality cost. Explains Suresh Agarwal, executive vice-president and head– distribution and strategic initiatives, Kotak Life Insurance Co. Ltd: “In a single premium plan, the mortality cost is comparatively higher than a regular premium plan. That’s because the sum at risk in case of a regular premium policy reduces with every premium instalment. Therefore, the mortality cost in a regular premium policy reduces every year.” Adds Pejawar, “For long-term regular premium Ulips, the premium allocation charge is heavily reduced over time and even becomes nil at times, increasing the proportion that is invested.”
Let’s take an example. Suppose you pay a premium of Rs 1 lakh for 10 years for a sum assured of Rs 10 lakh. Broadly, in year one if you die the insurance company will need to pay you higher of the sum assured or the fund value. So in this case, the company will need to pay you Rs 10 lakh. The company already has Rs 1 lakh from you, so the actual liability is Rs 9 lakh. In year two, when you pay another Rs 1 lakh, the actual liability of the company reduces to Rs 8 lakh, hence the mortality cost comes down. Mortality cost will be zero when the fund value of your policy equals the sum assured. But this does not happen in the case of a single premium policy since the sum at risk is constant. In this case, the mortality cost increases every year.
We compared a single premium policy with a regular premium plan. In 10 years, assuming a rate of 10% per annum, a premium of Rs 1 lakh in a regular plan and one-time payment of Rs 1 lakh in case of a single premium plan, a regular premium yielded a rate of 7.06% whereas the rate of return in case of the single premium policy was 6.29%. Since most single premium policies restrict their sum assured to five times the premium, we took the sum assured of Rs 5 lakh in case of a single premium policy and Rs 15 lakh in case of a regular premium policy.
As an insurance product
But it is not the cost alone that pinches. Insurance in a single premium policy is very little. Insurers offer the minimum prescribed sum assured of 125% of the single premium for individuals below 45 years of age and 110% for individuals above 45 years of age. However, the sum assured as of now is typically restricted to five times the single premium so that the premium is eligible for tax deduction under section 80C.
However, once the Finance Bill recommendations are implemented, this will need to change. Till now under section 80C, premiums paid towards a life insurance policy qualified for a tax deduction up to Rs 1 lakh. But if the amount of premium paid in a fiscal for a policy was in excess of 20% of the sum assured, then the tax deduction was allowed only for premiums paid for up to 20% of the sum assured. In other words, the sum assured needed to be at least five times the annual premium. Even the maturity benefits were tax-free under section 10(10D) if the premium was up to 20% of the sum assured.
As per the Finance Bill, 2012, the premium needs to be at least 10% of the actual capital sum assured in order to enjoy tax benefits under section 10(10D) and section 80C of the Income-tax Act. In other words, you will need to choose a sum assured of at least 10 times the single premium if you wish your maturity proceeds to be tax-free and the premium to qualify for a tax deduction of Rs 1 lakh under section 80C.
This will have a huge impact on returns. Says Agarwal: “In single premium Ulips, mortality cost turns out higher due to higher cover. If a person in his 50s buys a cover of 10 times the premium, the mortality cost can be 3-4% of the premium; mortality cost may result in a negative rate of return at higher ages though it offers higher cover.”
What should you do?
If you are a salaried individual or have a regular source of income, you are better off with a regular premium policy. But if you have had a windfall gain, then we advise you park your money in a mutual fund or a fixed deposit (FD). Says Suresh Sadagopan, a financial planner: “We advise a regular term policy and any windfall gain can be parked in mutual funds, FDs, tax-free bonds and Public Provident Fund depending on the goal and risk appetite.” Single premium Ulips offer low returns and little insurance.