Unit Linked Insurance Plans or ULIPs, is one of the most widely sold financial products, and in India, it has a penchant for bundling investment with insurance. The product gives a life insurance cover to the policyholder and allows the plan holder to invest in a bouquet of asset classes from equities, bonds, and money market instruments, among others.
What is a ULIP?
Let’s first understand what is ULIP? A unit linked insurance plan is that type of financial product offering a chance for investment with life insurance coverage. It can be described as a hybrid product given to the policyholders where their funds are distributed across various investment funds through their premiums. The goal of a unit-linked insurance plan is essentially to cover the existence or lives of policyholders while at the same time giving them a chance to increase their wealth through market-linked investments.
A unit linked insurance plan consists of two critical elements of structure:
- Insurance Cover: The coverage provided is that of life insurance whereby the assured sum is paid to the beneficiaries in case the policyholder dies during the term of the policy.
- Investment Component: Part of the premium collected gets invested in financial markets based on the options available in the funds selected, including equity, debt, or an apt combination of both. The investment amount changes with market fluctuations.
One of the significant USPs of ULIPs is that it is flexible. One can switch funds, top up the premium, and even partly withdraw their investments.
Working of ULIPs
The premium you pay during the investment in ULIP is split into two segments as described hereunder.
- Life insurance premium: This is utilized to pay up the insurance and preserve the life cover of the policy.
- Investment part: This part is invested in some fund options based on your risk appetite and the investment objectives.
With the passage of time, the investment can either appreciate or devalue based on the market conditions prevailing at that time.
A policyholder can also make a choice between the various types of funds:
- Equity Funds: Basic to equity and shares markets. These funds carry high returns with relatively higher risks.
- Debt Funds: Invests in bonds, government securities, etc.; these carry relatively stable returns with less risk.
- Balances Funds: a combination of equity and debt investment. It seeks a balance between risk and return. Money Market Funds: invest in short-term instruments such as certificates of deposit and treasury bills, which are low in risk but return stable.
The value of the units of a ULIP depends on the chosen funds. The money value of the units increases to result in high returns when the selected funds are performing well. Your returns could be decreased when the market performs poorly because the money value of the unit decreases.
Market Volatility of ULIP Returns
Market volatility represents the periodically changing nature of prices for various assets within financial markets, including stocks, bonds, and commodities. There are several sources of such price fluctuations, including changes in economic factors like inflation rates, corporate earnings, the effects of political events, and global pandemics and geopolitical tensions.
The impact of volatility of the market on ULIP returns could be understood in the following key ways:
- Fluctuating NAV:
The NAV of the underlying funds is directly proportional to your investment in ULIP. NAV refers to the price at which units of a specific fund are bought and sold. It keeps changing every day according to the performance of the underlying assets of that particular fund. The NAV of ULIP funds can be irregular, especially during times of excessive market volatility.
- Short-term gains and losses
ULIPs are long-term investment products that always have a policy term of about 10 to 20 years. At this short-term level, the instrument is generally prone to market fluctuations. Market crash and economic uncertainty can cause the value of funds to decline sharply, meaning policyholders suffer losses in the short term.
- Likelihood of doing poorly during bear markets
This is actually referred to as a bear market, when the stock market has fallen by significant margins for an extended period, usually more than 20% below recent highs. In such a market, equity-based unit linked insurance plan do not perform very well either, and the value of funds tend to decline. Returns from ULIPs, therefore, get huge implications if the market continues to be volatile or bearish for any considerable time period.
- Asset Allocations and Fund Switching Impacts
The facility to switch funds is one of the advantages for ULIPs. If the market becomes weak, a policyholder can change the assets allocated so that his/ her capital can be invested in more stable investments to protect it against risks that might arise in the market. However, such changes at times attract additional costs; therefore, making too many changes works as a hindrance to long-term returns for the ULIP.
- Time Horizon and Compounding Effect
One of the most effective means to nullify such volatility is to be invested for the long term. As investment instruments designed to work for the long term, ULIPs are compounded with the power of compounding—the returns on an investment generate their own earnings. Over a period of time, a well-chosen ULIP fund with consistent long-term growth potential can deliver attractive returns despite short-term market volatility.
Conclusion
Undoubtedly, market turbulence would result in short-term volatility of returns under the ULIP, though it is always important for investors to learn that returns from these plans are generated over the long term. The essence of ULIPs lies in a balance of insurance protection and market-linked investment; hence, it can be said to be one of the most versatile products for generating and managing wealth.
The best strategy in this scenario would be to reduce market volatility through a diversified investment strategy, systematic asset rebalancing, and focus on long-term financial goals. In doing so, the investors can maintain with the fluctuation of the market and be able to benefit from compounding to maximize returns from ULIP investments over time. Always assess your risk tolerance, financial goals, and investment horizon before investing in a ULIP so you can choose the right fund mix and have a well-balanced investment strategy.