Unit linked insurance plans or ULIPs are hybrid products that offer wealth creation, life cover and tax saving in one plan. A portion of the amount invested in ULIPs is allotted towards life cover while the remaining is invested in equities or debt instruments as per your choice. ULIPs manage assets worth Rs 3.73 lakh crore as of FY 2019-20.
Life insurance companies offer a plethora of plans under ULIPs. Broadly, they can be grouped according to their investment objective and the solution they offer. Before signing the dotted line, you need to know about your goals, the life cover you want, look at the charges levied by the fund, lock-in period (5 years), asset allocation, surrender charges and various other factors.
Here are the broad types of ULIPs:
Aggressive Allocation
These funds take a higher allocation to equity. The allocation towards equities could go upwards of 80%. The remaining portion is invested in debt and cash. These funds are aimed at investors who have a longer time horizon and a higher risk appetite. The fund value which you get at maturity or surrender will depend on the prevailing market value of the investments.
You can check the performance of ULIPs here.
Balanced Allocation
As the name suggests, the funds invest in a mix of equity, debt and cash. The exposure to equities differs across schemes. The allocation towards equities would also depend on the type of fund you choose. These ULIPs are relatively less risky in comparison to aggressive allocation funds.
Dynamic Asset Allocation
These funds have the agility to manage their asset allocation between equity and debt. Some of these funds change the allocation base on the valuations of the market by using Price to Earnings Per Share or P/E multiple of the index or the 50 large cap stocks. They can swing 100% to equity and 100% to debt.
Conservative Allocation
These funds have a higher allocation (around 70%) towards debt and cash and the remaining portion is invested in equities. Such funds are suitable for investors who wish to participate in equities with lower volatility. Do note that a correction in the market can affect the fund value of such funds but they will witness a lower drawdown as compared to aggressive allocation funds since debt allocation will provide a cushion to the portfolio.
Short Duration
These funds maintain average maturity of the portfolio at around six months. They invest in government securities treasury bills, corporate securities, and money market securities. A major portion (90%) is invested in AAA rated paper.
Ultra Short Duration
These funds carry lower risk in comparison to short duration funds. They invest in debt and money market instruments while attempting to protect the capital. A major portion is invested in a money market, cash, government and corporate securities carrying AAA and A1+ equivalent securities.
Long Duration
As the name suggests, these ULIPs invest in longer tenure securities. The average maturity of the portfolio could be over 6 years. The modified duration of such ULIPs tends to be higher than ultra short duration and short duration funds, typically four years and above. Higher modified duration means higher sensitivity of the portfolio in response to interest rate changes.
Government Bond
These ULIPs invest at least 90% of net assets in government securities also known as gilt securities. Though gilt securities don’t carry credit risk (risk of the issuer defaulting on the loan), they are highly sensitive to interest rate movements. These funds typically do well when interest rates are declining since bond prices and yields have an inverse relationship.
Market Capitalisation/Index Funds
ULIPs offer a variety of schemes like large caps, mid caps and multi cap strategies. Investors should ideally opt for multi cap ULIPs which diversify across market caps.
Besides actively managed ULIPs, insurance firms offer index funds that track broader indices such as Nifty or Sensex. These funds may have higher tracking error due to restrictions on investing in listed group companies. These funds charge a lower fund management charge as they just mimic the index.
Thematic funds
Some funds invest in a particular theme such as consumption or adopt negative screening such as avoiding certain companies involved in gambling, lotteries/contests, animal produce, liquor, tobacco, entertainment (films, TV, etc) hotels, sugar, leather, banks and financial institutions. These are akin to Ethical or Shariah funds offered by mutual funds.
Life Cycle/Solution Oriented
These funds work on the principle that your risk appetite reduces as you age. Life cycle funds such as retirement plans decide the allocation to equity and debt as per your current age and shift the allocation from equity to debt when the policy is set to mature. The thumb rule of investing in equities is allocating 100 minus your current age in equities. But this is not cast in stone. A person who has retired may have a higher risk appetite can choose an option accordingly. Insurers also offer ULIP pension plans which offer an annuity.
Summing up
Under each of these fund categories, insurers offer multiple plans (ranging from an allocation of 100% debt and 100% equity to suit your goals and risk appetite) and allow you to change allocation as per market conditions. You can switch between any of these plans during the course of the policy. Some policies also allow you to invest the entire corpus in one plan (debt-oriented scheme). From this, certain units can be transferred to an equity ULIP, just like a systematic transfer plan. You need to consider the tax aspect resulting from such switches.
Unlike in mutual funds where the scheme name (post recategorisation) clearly reflects the investment objective of the fund, the nomenclature of ULIP plans differs within each category. For instance, multi cap funds are known as growth opportunities, super select equity, virtue fund, life select equity, pure equity and so on. This could make choosing ULIPs a daunting task. Thus, it is advisable to read the ULIP factsheets and other fund literature before investing.
Here is the full list of ULIP categories rated by Morningstar.
