When it comes to premium pricing, it is found that the costs of ULIPs are far higher than their counterparts-term and endowment. The reason for this high premium lies in the plans working structure, and what it has in store for an investor. To get an answer to the question of why Unit linked plans quote a higher premium, let’s begin by understanding what exactly it is.
ULIP- A Multi-Benefit Option
Unit linked plans (or popularly called as ULIPS), though categorized as life insurance policies vary in great degree from term or endowment plans. To start off with, they not only give you protection in the form of a sum assured, they also provide an opportunity to accumulate wealth in case of survival. So what you typically get is an investment and insurance option blended in one single plan.
Basis of Premium Calculation
A ULIP being a combination of insurance as well as investment comes with two parts to it- a sum assured payable on death of policy holder and, an investment component that generates returns. The calculation of a ULIP premium stems from this requirement to meet both these needs. From the premium that is paid for, a portion goes towards meeting the life cover and another towards investment. This is one of the main reasons why premiums are far higher in ULIP Plans, as they have a dual role to play.
Premiums vary from policy to policy and person to person. What goes in deciding your premium amount depends on the risk perceived by the insurer. The main factors are age, profession, place of residence and lifestyle. It is on the basis of these factors insurance companies fix your premium for the sum assured opted for.
Break Down of Premium- What Are You Paying For?
Unit linked plans deduct certain expenses. Post the deduction of these expenses, the premium is divided between providing a life cover and making an investment. Units are allocated for the amount invested, in a fund of your choice. The fund could be equity, debt, or a combination of the two. The value of the units allocated depends on the performance of the underlying fund. The charges collected are as follows.
- Mortality charges: These are the charges you pay for the life cover you get. It is the actual cost of insurance, making up around 15% of your premium. It is calculated on the basis of the average Indian life-expectancy ratio (as prescribed in IRDA’s “Life-Mortality table”).
- Fund Management Charges: For managing and investing your money in a particular fund, a fee is charged by the insurance company. The amount is anywhere between 1 to 1.5%, of the assets under management. The charge depends on the type of underlying fund of your policy. The more aggressive the fund manager’s role in the portfolio, the higher the charge.
- Policy Administration Charges: These charges are towards the insurer’s paperwork, maintenance and administration. It is charged on a monthly basis, as a flat rate of around 0.5% of the annual premium chargeable per month.
- Premium Allocation Charge: This is a charge that goes towards, any commission/ service charge for the insurance agent. It is deducted from your premium before the balance is invested in the fund of your choice. Premium allocation charges are highest in the first policy year. It is deducted upfront from the premium paid on a yearly or monthly basis, depending on your policy
- Service Tax Charge: Mandated and declared by the government which is currently at 10%+ 3% education cess, service tax is applicable on all charges such as fund management charge, premium allocation, mortality.
Other Miscellaneous Charges:
- Rider charges: If you seek a more comprehensive cover and opt for a rider such as a personal accident cover or critical illness benefit along with your life cover, you are charges an additional premium amount. The cost depends upon on the rider you choose.
- Switch Charges: If you opt to switch over from one fund type to another in your ULIP policy, you may be charged for doing so. This charge is levied when the switch is actually made, at is a flat rate.
Making the most of your ULIP
Unit linked plans definitely do quote high charges. And with the performance of the plan linked to the markets, often during times of a market decline, the high fee structure could affect the plan’s returns. To make the most of your ULIP stay invested with a long term horizon of 10 to 15 years. In the long term, risks associated with market fluctuations are greatly reduced, thus fetching you higher returns. Another reason for looking long term is that the initial policy years of a ULIP have a high cost structure. The commissions in the first year for a ULIP are around 18%, 7%in the second year and 4% thereafter. With years as the cost comes down substantially, a larger part of the premium is invested in the chosen fund, fetching you more from your investment.
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