Many consider ULIPs to be a product that is frequently sold misleadingly. It's important to understand how to avoid falling into the ULIP trap and make smart choices for your financial portfolio.
Understanding ULIPs
Unit Linked Insurance Plans (ULIPs) combine the elements of insurance and investment, allowing policyholders to invest in various funds while providing life insurance coverage.
The dual nature of ULIPs makes them a unique financial instrument, but it's precisely this complexity that can lead to mis-selling.
Mis-selling in investments happens when sellers or advisors use misleading practices to promote financial products.
This can include giving false information, not sharing risks, or suggesting products that aren't suitable, causing investors to make choices that harm their financial well-being.
Why Are ULIPs One Of The Most Mis-Sold Products?
Explains Chethan Shenoy, director & head - of product & research, Anand Rathi Wealth: “ULIPs are often prone to misrepresentation due to several factors.
Firstly, these insurance products provide higher commissions to agents, creating a potential conflict of interest where the focus may shift from meeting the client's benefits to maximizing commissions.”
According to experts, at times, such commissions can be as high as 40 per cent in the first year.
“Additionally, ULIPs offer a mix of life cover and investments, making it essential for potential buyers to thoroughly understand the product's complexities. Furthermore, the allure of tax benefits on premium payments (under Sec 80C) and tax-free maturity proceeds (under Sec 10(10)) adds another layer to the selling strategy, often leading to misunderstandings and miscommunication,” adds Shenoy.
Unfortunately, the level of financial literacy in India is so low that people are easily misguided when it comes to making financial decisions. “I am very sorry to say that banks are the places where products are being mis-sold. The insurance arm of banks often uses aggressive sales tactics to sell products. Bank employees have steep targets to sell products like insurance, credit cards, mutual funds etc. It’s not right to label everyone as unethical, but regrettably, many relationship managers deceive people to bag incentives and high commissions. They do not assess the need of the prospect,” says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.
Often ULIPs and endowment policies are typically sold along with home and personal loans. “ULIPs are still sold as an alternative to investing in Mutual Funds. The biggest mistake that people make is mixing investments and insurance,” says Sen.
What Are One Of The Most Common ULIP Sales Pitches?
“In the realm of ULIP sales, several pitches aim to attract potential clients. One prevalent pitch emphasizes clients enjoying market-linked returns coupled with a complimentary life cover, offering a seemingly attractive dual benefit. Sales representatives may highlight past fund performance, showcasing impressive returns with the added advantage of life cover benefits,” adds Shenoy.
The appeal of tax benefits on premium payments and tax-free returns further sweetens the deal. The promise of unlimited free funds switches between equity and debt without charges, coupled with reduced charges after the initial five years, aims to position ULIPs as an enticing investment option.
Additionally, the five-year lock-in period is often presented as providing ample time for fund growth, creating a sense of security for prospective buyers.
How Can You Avoid Getting Into The ULIP Trap?
Avoiding the pitfalls associated with ULIPs requires a thoughtful and informed approach. One crucial strategy is to maintain a clear separation between life cover or protection objectives and return on investment objectives.
For the primary purpose of life cover, opting for a simple term plan provides a straightforward and effective solution. On the other hand, for those seeking investment returns, considering mutual funds might be a more transparent and manageable choice.
Additionally, for individuals looking to gain tax benefits, exploring Equity Linked Savings Schemes (ELSS) could be advantageous, as they offer tax benefits on investments (under Sec 80C) and tax-free returns (under Sec 10(10D)). By understanding these distinctions, investors can make well-informed decisions, avoiding potential traps associated with ULIPs.
“If you realise you have been a victim of mis-selling during the free-look period, simply return the plan. If the free-look period is over, in the case of traditional plans, you can either make it a paid-up policy or surrender it. This would depend upon various factors related to the product. The ideal way to avoid the trap is to understand your requirements in the first place,” says Sen.
