ULIP stands for Unit Linked Insurance Policy. A ULIP is a life Insurance policy which provides a mixture of risk cover and investment. (ULIPs) as an investment avenue are closest to mutual funds in terms of their structure and functioning. It has kind of revolutionized Indian insurance industry. A decade back almost all insurance plans sold in India was Endowment Plan; however, after private players entered into the industry and stock market boomed, ULIPs displaced Endowment from its top position. Now over 60% of new plans sold in the country are ULIPs. When we talk of Insurance as an investment option, ULIPs have an important role as many of the investor nowadays goes for this as a profitable avenue.

With profits’ policies are called so because investment gains (profits) are distributed to policyholders in the form of a bonus announced every year.  ULIPs also serve the same function of providing insurance protection against death and provision of long-term savings, but they are structured differently.

In ‘with profits’ policies, the insurance company credits the premium to a common pool called the ‘life fund,’ after setting aside funds for the risk premium on life insurance and management expenses. Every year, the insurer calculates how much has to be paid to settle death and maturity claims. The surplus in the life fund left after meeting these liabilities is credited to policyholders’ accounts in the form of a bonus. In a ULIP too, the insurer deducts charges towards life insurance (mortality charges), administration charges and fund management charges.

The rest of the premium is used to invest in a fund that invests money in stocks or bonds. The policyholder’s share in the fund is represented by the number of units. The value of the unit is determined by the total value of all the investments made by the fund divided by the number of units.

If the insurance company offers a range of funds, the insured can direct the company to invest in the fund of his choice. Insurers usually offer three choices — an equity (growth) fund, balanced fund and a fund which invests in bonds. In both ‘with profits’ policies as well as unit-linked policies, a large part of the first year premium goes towards paying the agents’ commissions. In ULIPs, the investment risk is borne by the policy holder and hence returns are not guaranteed. The dynamics of the capital/stock market have a direct bearing on the performance of the ULIPs. Under this policy the insurer allocates the total premium into various units. The insured is also given the opportunity to choose the option of investment units. Most of them prefer to allocate them in financial investments and assets. The number of units they choose on each option differs from individual to individual. Some of them may choose to invest more on properties while the rest prefer to invest more on financial instruments such as shares, debentures, etc.

Likewise the insurer takes care to allocate a unit of the premium for insurance maintenance and the ancillary expenses. The insured will have no choice over this. The insured is also excused from paying income tax for the amount received from the company. However this policy does not guarantee profits like the previous and is therefore risky as far as returns are concerned. ULIPs fundamentally work like a mutual fund with a life cover thrown in. They invest the premium in market-linked instruments like stocks, debentures, corporate bonds and government securities. Investments in ULIPs help to gain tax benefits under Section 80C.