Out of the blue, the Indian insurance industry is the talk of Dalal Street as it has become a major contributor of investment in the equity market. Though premium collection slowed to some extent in early 2009, it has been gaining pace with the overall healthy market sentiment. Premiums collected under ULIPs are a major driver in boosting equity investment. Renewal premium of the industry in the ULIP category increased from Rs.26,638 crore to Rs.37,543 crore, an increase of 41 percent year-on-year. Insurance companies invested Rs.44,358 crore in equity between April and December 2009.
The practice of mis-selling ULIPs has largely been curbed after the insurance watchdog, the Insurance Regulatory and Development Authority (IRDA) introduced investor-friendly rulings, capping charges up to three percent and 2.25 percent for ULIPs with maturities of up to 10 years and those beyond 10 years, respectively. Moreover, the IRDA ruling on solvency ratio, corporate governance, public disclosures, payment made to intermediaries and allowing unit-linked health insurance plans, have greatly benefited the insurance industry.
How do ULIPs perform well in the long-term?
The major objective of ULIPs is to build wealth, steadily in the longterm as well as providing insurance cover, though investors must be clear that, investing in ULIPs is not to get high insurance cover. A fund manager in insurance companies can hold stocks for a longer period than his counterparts in other industries. Hence, churning in portfolio stocks, measured by Portfolio Turnover Ratio (PTR) is relatively less or negligible. Since churning involves costs, it has a major impact on a fund's performance. Higher the Portfolio Turnover Ratio, higher is the cost involved. Moreover, IRDA's cap on charges including a cap on Fund Management Charges (FMC) in case of ULIPs, bring more benefits to policyholders in the form of increased returns. A close look at the performance of other market related products vis-à-vis ULIPs throws up a startling fact. Other market related products lag ULIPs' returns by a large margin in the long run, which confirms that ULIPs are an ideal investment vehicle for wealth creation in the long term. On an average, the historical FMC in other market related products are lower. For mutual funds they come to about 2.1 percent whereas for ULIPs, the maximum FMC is capped at 1.35 percent.
For example, a periodic investment of Rs.1 lakh in a diversified equity linked fund (ELSS) for 15 years grows to Rs. 28.54 lakh at an assumed growth rate of 10 percent, giving a net yield of 7.69 percent
(Considering an average FMC of 2.1 percent). The same amount invested in ULIP for the same period may range from Rs.28.63 lakh to Rs.31.59 lakh at an assumed growth rate of 10 percent, giving a net yield ranging from 7.97 percent to 9.03 percent. The final value falls further if we consider other tax-saving instruments such as PPF, which gives a return of eight percent a year. An investment of Rs.1 lakh a year in PPF for 15 years grows to Rs.27.15 lakh.
So, clearly, ULIPs score over other products in terms of returns and additional benefit such as insurance cover. But it scores below PPF as an investment in ULIPs involves high risks. Returns on ULIPs rise due to lower FMC if the investment choice is a debt fund and assumed rate of return is 10 percent (in debt funds, the FMC is generally about 0.75-1 percent). The table shows the different returns.
However, the high entry costs and operational costs mar the performance of ULIPs on shorter maturity periods. Thus, we see that ULIPs appear to be the obvious choice for investments for creating considerable wealth in the long term.
