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IRDA’s new efforts to differentiate ULIP from Mutual Funds

Uptill now theres a big battle between Unit Linked Insuarance Plan (ULIP) and Mutual Fund (MFs): which is set to finish or say resolved

The long-standing debate over the suitability of Unit Linked Insurance Plan (ULIP) and mutual funds is set to come to an end as the recent announcements by the IRDA, clearly demarcates the playing fields. The insurance industry is buoyant as it views the new guidelines as an endorsement of the fact that ULIPs as an investment tool has become important enough for the regulators to sit up and take notice and the industry players are unanimous in their opinion that the growth of the overall industry in the future will be led by ULIPs.

As per IRDA’s new guidelines, there has to be a minimum lock-in period of three years for ULIPs, a minimum term of atleast five years and the death benefit payable or sum assured under the single-premium product has to be at least 125 per cent of the single premium paid, among other major policy changes. The new guidelines will stop ULIPs being positioned as short term investments products, and they will look less like mutual funds and more like insurance policies. The new move is expected to derail the robust growth of ULIPs in the country somewhat which till now have banked on their flexible investment mandate to lure investors.

New ULIPs now come with a minimum term value of five years, whereas in mutual fund’s ELSS there is a lock-in period of just three years. If an investor decides to withdraw money from ULIP after three years, the amount depends on the surrender value given by the respective insurance company. Ideally ULIPs are considered for those classes of investors who want to put money in a investment product that earns them decent returns by further investing the money in the market, and at the same time ensure a life cover and tax efficiency.

As per the new guidelines, no loans can be granted under ULIP schemes. Further, insurance advisors who sell ULIPs have to be given separate training before they are authorised to sell them. Also, advertisements have to clearly bring out the fact that ULIPs are different from traditional insurance products.

In the wake of the new guidelines insurance companies are busy re-positioning ULIPs and the message is not to view these products as short-term investments to reap windfalls from market fluctuations. The guidelines therefore are unlikely to dampen the growth for companies that are already focussing on products with a medium to long-term cover, though the guidelines surely take away some flexibility from a customer. The new guidelines are intended to enhance transparency levels and provide better understanding of the product to prospective investors, and if applied in principle, ULIPs will remain as attractive as they were earlier.

However, the new guidelines by the IRDA which allows insurance companies to accept new policies, fund switches, withdrawals and surrender requests upto 4.15 p.m, well after the market closes, has sparked a controversy. It has thrown the insurance product to potential misuse. What this translates into is that an investor can switch from liquid fund to an equity fund at the end of the market hours, with the complete knowledge of how the markets have transpired during the day and gain any arbitrage opportunity thereof. ULIP have long been considered insurance industry’s answer to mutual funds, and were the only weapon which insurance companies had to ward off the threat posed by AMCs. Now, there has been always a parallel comparison of unit linked insurance products and mutual funds, but new guidelines allows transactions till 4.15 p.m, mutual funds companies have to shut shop a good half an hour before the market closes to control any misuse.

Mutual funds are essentially short to medium term products. The liquidity that these products offer is valuable for investors. ULIPs, in contrast, are now positioned as long-term products and going ahead, there will be separate playing fields for ULIPS and MFs, with the product differentiation between them becoming more pronounced. ULIPs now do not seek to replace mutual funds, they offer protection against the risk of dying too early, and also help people save for retirement. Insurance has to be an integral part of one’s wealth management portfolio. Further, exposure of Indian households to capital markets is limited.

ULIPs and mutual funds are, therefore, not likely to cannibalise each other in the long run. While ULIPs as an investment avenue is closest to mutual funds in terms of their functioning and structure, the first and foremost purpose of insurance is and will always be ‘protection’. The value that it provides cannot be downplayed or underestimated. As an instrument of protection, insurance provides benefits that no investment can offer. It is important for an investor to understand his financial goals and horizon of investment in order to make an informed investment decision. The decision to invest in either a mutual fund or a ULIP should depend on the time period of investment, individual financial goals as well as risk taking appetite, and it’s about time the industry and customer realise it.

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