Monday, March 23, 2009


These days we see so many ads in print and electronic media about the capital guarantee ULIPs being branded and promoted as the ultimate solution to investor worries in this bear market. There are many more such plans and all the insurance companies in India have this product in their portfolio. The prospect of capital being guaranteed in this volatile market scenario is very tempting one. Lets try and figure out all about these products and understand how is that they are promising to deliver what others can’t.
Capital Guarantee ULIPs, by definition, is a product where the money invested in the plan is guaranteed i.e. the investor will at least get back his money invested in the plan ,unlike, normal ULIPs where the investors gets the fund value as on the redemption date. This fund value may or may not be higher than the total money invested in the plan by the policyholder.
Most of the capital guarantee ULIPs promise capital preservation and as such there is no chance of capital erosion in the long run (in the short run, it might not hold true).The policyholder gets higher of the fund value or the money invested.
These products, though seem attractive, are not really in the best interest of all the investors due to some serious flaws in it. They are
- Capital means money invested net off charges – By capital guarantee, one would imagine, that the total money invested in the plan is guaranteed. However, that is not the case with ULIPs. Here the term capital means the money actually invested in your fund net off charges i.e.
Capital = Premium paid – Charges
And we all know that the charges in ULIPs are extremely high and can go up to 50% of the premium paid in initial few years. Subsequently it does decrease but still it is much higher than other investment tools like MF etc. So, for instance if you pay Rs 10000 as annual premium and the charges are40% , then the capital guaranteed on this would be Rs 6000 only ( RS 10000-4000) and not Rs 10000 as people would expect. This is certainly not capital guarantee.
- Low headroom for capital appreciation – Since insurance companies endeavor is to protect capital , they primarily invest the money in debt instruments where there is no scope of capital erosion. But, this also limits your chances of capital appreciation in the long run unlike equities. People invest in long term instrument like ULIP primarily for wealth creation along with insurance cover and as such this does not serve them well on this parameter. Also, if they have to protect your capital via investment in debt instruments, you may look at investing in debt instruments yourself(via mutual funds, bonds etc) which will not only give you capital protection but also has lower charges.
- Low rate of returns (4%) - Most of these plans guarantee returns as low as 4% which is even lower than inflation at times. The normal fixed deposit in your local bank will get you more returns on your money than this.
- Low surrender value – Most of these funds penalize you if you were to withdraw or exit out of the plan prematurely. This way they ensure that you stay invested for a long period of time. This in itself is not bad, but, takes away the liquidity aspect from this instrument.

- UTI Fiasco was a result of this – Since Mutual funds or ULIPs invest the money collected from investors in the market, the returns generated on this is also a function of the market dynamics. No one can guarantee any returns on the market . This was amply proved by the UTI fiasco where the investors were promised a guaranteed rate of return on their investment. The Company could not honor its commitment and finally the Govt Of India had to bail out the investors. So we need to learn our lessons from this as well.

The insurance company executives claim that they can guarantee returns simply because the returns are so low (4% or so). I have a problem with this and that is why anyone would invest in a plan which offers such low returns in the name of guaranteed return when they can easily get more out of bank FD.
I would not recommend people to fall for such policies. You may look at so many debt instruments available in the market if capital guarantee is your primary concern. You may invest in FD, PPF,NSC, KVP, Debt based MF etc. By doing so chances are you will end up with better returns due to low charges in these products. If you want capital appreciation for wealth building then invest in good mutual fund . If you want to invest in ULIP only , then go for the ones which have more than 50% of corpus invested in equities. What would I do? I would invest in a well diversified mutual fund like Reliance Growth and buy a term plan from LIC.
Please share your thoughts in the comments section below.
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