ILIP - The Shield That Grows

In this week's FinMail we are going to discuss a new type of Insurance Product that is back on the table of the IRDAI - the Insurance Watchdog. We discuss it as a concept and compare it with currently available Insurance Products.

The Story

We might soon see again ILIPs - Index-Linked Insurance Products in India. The Working Group Committee of IRDAI led by Dinesh Pant, Appointed Actuary of LIC India was given the task to study the relevance of ILIPs in India. ILIPs were discontinued in India back in 2013 due to aggressive misselling of these products by Insurers who sold these ILIPs to the customers without making them aware of its disadvantages. And also the returns were not fixed in ILIPs, these plans were withdrawn.

Why are they back?

Since the Pandemic, there has been an increasing demand for products that provide guaranteed returns. And because the rates of the government securities were at historical lows, Insurance companies are also bound to decrease their bonus declarations. And there are reports that Insurers themselves have approached IRDAI to consider the relaunch of ILIPs.

The Working Group Report was submitted just a few days ago and it stated that ILIPs could definitely be a good alternative to the existing ULIPs. It can also fill the gap of the products available between the Traditional Insurance Plans where the returns are low with little risk & the features are also somewhat less transparent while with the ULIPs there are chances of higher returns with the risk of the funds being borne by the Policyholders. So what are ILIPs? How do they work? And how it is different from ULIPs & Traditional Insurance Products? Let's understand them all.

The Gap Between Endowment Plans and ULIP:-

Now we all know what endowment plans are and if not let us understand it simply in brief.

Endowment Plans:

Endowment Plans or Traditional Insurance Plans are plans that provide Insurance Cover with Investment option bundled up in a single plan. The premium you pay has two proportions - one is for Insurance and the other one which is the major proportion is invested by insurers that will provide growth opportunities and benefits at maturity. Now Traditional Insurance plans are not preferred because of the lower returns that it provides. It matches with the inflation rate and sometimes provides you even lesser than that. And that's where ULIPs come in.

ULIP: Unit Linked Insurance Plans

Unit Linked Insurance Products is a product that is designed to provide the policyholder an Insurance cover with an Investment Benefit better than the Traditional Investment Products.

Under ULIPs similar to the Traditional Plans, the premium is divided into two portions, The Premium of the Insurance Cover and the rest major amount is Invested. And unlike Traditional Plans where the Investment Premium is invested by the decision of the insurer, here in ULIPs, the decision is passed on to the policyholder. The policyholder has to choose the plan in which he/she wants to invest in.

These plans are just like Active Mutual Funds that are managed by Fund Managers and a certain fee is charged from the fund balance for their service. As the policyholder has control over where he/she wants to invest the money, the risk too is borne by the policyholder.

After allocating a premium for the insurance plan, the remaining amount is invested in the selected fund and a certain number of units are allocated to the policyholder depending on the unit value at the time and hence the name Unit Linked. Here, there is a lockin period of 5 years where the policyholder can not withdraw his/her money till 5 years. The amount of premium paid is deductible for Tax Benefits up to the limit under Section 80C and also capital gains are exempted from tax.

So basically ULIPs are Insurance Plans combined with Mutual Funds but here the returns are typically lower than similar Mutual Funds because of the various charges & fees involved.

Now, what the gap between the Traditional and ULIPs is that while Traditional Products provide security of amount but lower returns, ULIPs are much riskier than Traditional Plans and costlier too so the gap refers to the absence of product that can provide better returns with low cost, and that is where ILIPs try to fit in. Let us understand what ILIPs are.

ILIP: Index-Linked Insurance Products

ILIPs are similar to ULIPs in a way that the mechanism of both ILIPs & ULIPs can be compared to mutual funds. But where ULIPs invests in a fund that is managed by Fund Managers or as we call them active funds, ILIPs provide investment options in a Passive way wherein the Investment Premium that remains after allocating the Premium of Insurance Cover from the Total Premium is invested in Indexes like Nifty50 or Sensex or even 10-year Benchmark G-Sec Index, etc.

Here they are replicating a benchmark and hence there is no major difference between the return of the benchmark and ILIPs but just the cost difference.

ILIPs could be favorable amongst Insurance Buyers because of these reasons:-

• It can offer returns that can beat the inflation rates.

• Fund Manager has no major role so the debate that fund manager will not outperform doesn't concern ILIPs.

• Less expensive than ULIPs.

• Passive Investing Technique.

• Tax Benefits similar to other insurance products.

Our Point of View:-

ILIPs did exist back in 2013 but it was shut down because of aggressive misselling and the ambiguity of the product features. ILIPs is definitely better than ULIPs because of the low-cost factor and the passive investing mechanism and hence there's no much to worry about. But it still is an Insurance product bundled up with Investment Benefits and thus not an ideal option for Investment. We'd still prefer a term plan coupled with a good Mutual Fund or a bunch of good stocks.

That is it for this week's FinMail. Stay safe & we will see you next week.