Should we invest in Highest NAV ULIPs?
Risk involved in ULIP:
ULIP (unit linked insurance plans) is a life insurance policy mixed up with an investment in the stock market. A portion of the premium paid by you is utilised towards taking a pure endowment life insurance policy and the remaining amount is invested in the stock market by buying shares of companies chosen by the fund manager.
Needless to say the portion of amount invested in the stock market would be exposed to stock market fluctuation. Just see the price of a stock in December-2007 when the market was peaking at 20K to 21K. When the market crashed afterwords shares of almost all the companies in the market fell around 60% to 100%. Again the see the recovery phase from March-2009. Most of the stocks gained a decent recovery. Some stocks were even surpassed their earliet highest price. So, the price of the units, as measured in net asset value (NAV), which is an average value of stock held in a particular scheme of the Insurance company can fluctuate a lot.
Take the case of a person buying a ULIP. He always has the risk that his capital invested in the units can be eroded, if the markets is weak. Thus at maturity of the policy, one might not get a high return that one expected at the time of buying the ULIP.
Capitalising the risk involved:
Risk involved in the investment in the ULIP is actually a drawback. But insurance companies are now trying captialise this drawback itself for mobilising new funds in the form of providing the scheme known as “Guaranteed NAV ULIPs”
Highest NAV ULIP- The real name is Constant Proportion Portfolio Insurance:
The investment process followed in these “highest NAV guaranteed” Ulips is called Constant Proportion Portfolio Insurance — a trading strategy designed to ensure that a fixed minimum return is achieved at a set date in the future. This strategy involves a continuous re-balancing of the portfolio of investment between equity and debt.
Consider a Ulip promise to pay highest NAV in the next seven years that starts today at a NAV of Rs 10. Let us assume that 100 per cent of the allocated premium is invested in equities.
Now, the market goes up and at the end of the first year the NAV increases to Rs 15. This is the highest NAV of the Ulip till now and the insurer has to make sure that the policyholder can be repaid at the end of the remaining six years on the basis of the Rs 15 NAV.
Shuffling is the key:
The company would now transfer a part of investment made in the equity market to debt instruments such as govenment or private bonds that ensure a return of Rs 15 after six years.
In the second year, the markets do down and the NAV declines to Rs 11 from Rs 15. However, the insurer doesn’t need to do anything as the return of highest NAV has been ensured by the investment bebt market.
Now comes the prudency of the fund manager of the scheme. Since is market is low as we assumed that NAV has declined from Rs.15 to Rs.11, the fund manager has the liverage now to re-invest part of the amount withdrawn from the equity debt when the NAV was Rs.15, in the equity market again at a lower price. This action may lead to appreciation of NAV further. But this element of risk is not to be taken in the case of Highest NAV schemes as there no such declaration by the company to the extent that the appreciation gained which is available in the debt fund will be re-invested in the equity market. Obviously, the NAV of this scheme would tend to appreciate at a slow phase compared to non-guaranteed ULIPs or pure mutual fund schemes.
As per the fine print of these “Highest NAV” schemes, in the subsequent years also , if the stock market goes again a portion of the investment available in the equity fund will be transferred to debt instruments.
This sort of shift of funds from equities to debt instruments would be continued and when the policy matures, all the investment made by the policy holder would go to debt instruments.
Highest NAV guaranteed Ulips thus turn out to be primarily debt-oriented rather than equity-oriented plans — you can expect a gross return of between 8 per cent and 10 per cent on investment. But since there are various charges associated with a Ulip, your net return could be still lower at 5 to 7 per cent. Besides, guarantees come at a cost. The total cost of these guaranteed Ulips are higher than that in a non-guaranteed product.
This guaranteed NAV scheme is not offered by Mutual funds as they are not allowed by the market regulator Sebi to provide any kind of guarantee to investors either on capital or on investment returns.
But insurance regulator IRDA allows life insurance companies to offer guarantees on their products, even when these are market-linked.
Even the life cover and the tenure of such highest NAV guaranteed Ulips are not as beneficial to customers as in non-guaranteed insurance plans. The sum assured offered is generally five times the annual premium and the policy term is 10 years. So, these plans are not only giving you a smaller life insurance, they are covering a shorter span of your life.
Who should Invest in These Products ?
If you are looking for modest returns, like 8-10%, you can invest in these policies. The return of these policies may be high in the beginning, if market does well; but when market starts performing badly, the returns can take a hit and then be in a tight range. Your NAV will be protected for sure.
The bottom line is if you are more concerned about the worst side of market investment, which may lead to capital erosion some times, Highest NAV/Guaranteed NAV Scheme may suit you. But you got be contend with low or medium capital appreciation.