Plans combining investments in insurance and wealth development are becoming increasingly popular on the market as more investors are drawn to the idea of obtaining both stable life insurance coverage and wealth accumulation from a single investment. Here, ULIPs (Unit Linked Insurance Plans) have become attractive alternatives for investors who are more accustomed to taking on market risks and prefer to make long-term investments. ULIP plans come in various forms, depending on several variables/factors. Have you heard of Type 1 and Type 2 ULIP policies? Understanding these two categories is crucial if you are looking to buy a ULIP policy for your portfolio. Here is a quick overview of both these plans after we dive a little deeper into the basic concept behind a ULIP.
What is a ULIP policy?
ULIPs combine insurance and investment plans; they offer the policyholder life insurance protection and the potential to build wealth in the future through investments in various types of funds. These funds can be Equity, Debt, Hybrid, or Liquid funds. You can choose based on your risk appetite and how much return you expect. The premiums you pay are invested in the funds of your choice after all applicable charges have been deducted.
Over time, your investment produces returns per the fund performance, and your corpus grows. At maturity, you get your accumulated returns as benefits. But what about the benefits that your nominees are eligible to receive? Because of the presence of life insurance, they are liable to get a death benefit, but what if there is a sizeable corpus as well? What will happen in that case?
This is where the distinction between Type I and Type II ULIPs comes into play.
What are the different types of ULIPs?
Once you have understood the basics of what is a ULIP policy, you can choose from two types of ULIPs. Here is a brief analysis:
Type 1 ULIP – In this ULIP policy, the insurance provider will pay the death benefit equal to the greater of the fund value or the sum assured of the plan. Let’s use an example to illustrate this. Assume you have paid premiums for this plan with an insured Rs. 30 lakh sum. The fund value has been increasing concurrently with positive returns over time. At the time of your demise during the policy term, if the fund value has reached Rs. 50 lakh, the fund value would be paid out as the death benefit.
Type 2 ULIP: If the policyholder passes away suddenly, the sum promised, and the accumulated fund value is paid out to the policyholder’s nominee(s). Let’s say the fund worth is Rs. 50 lakhs and the plan’s payment assured is Rs. 40 lakhs. In this instance, the insurance provider will pay Rs. 90 lakh to the policyholder’s beneficiaries.
How is the Sum at Risk formula applied to ULIPs?
The amount of risk the insurance company puts on the policyholder’s life is known as the “sum at risk.” Suppose the death benefit is either the fund value or the sum assured (whichever is higher). In that case, the sum at risk will decrease over time, as the fund value will keep growing and eventually surpass the sum assured so that what the insurance company pays out is not from their pocket.
Therefore, for Type I ULIPs, where the death benefit is either the Fund Value or Sum Assured, whichever is the greater amount, the Sum at Risk = Sum Assured – Fund Value.
The formula for Type II ULIPs, however, is Sum at Risk = Sum Assured for the entire tenure, as both the sum assured and the fund value are payable upon the policyholder’s death. This is so that the amount at risk is not decreased by the fund that has grown over time.
How should Type 1 and Type 2 ULIPs be chosen?
The mortality costs (that go towards the life insurance component of your ULIP) are the primary criterion for comparing Type 1 and Type 2 ULIPs. As the fund value increases, the sum at risk in Type 1 ULIPs decreases until it eventually becomes zero, leaving more money available for investment and a larger return potential. The sum-at-risk is fixed in Type 2 ULIPs, making the mortality charges constant and comparatively greater. The value of the fund at maturity may be affected by this.
Because they offer a combined payout of the sum promised and fund value, Type 2 ULIPs are good options if you’re searching for secured death benefits, but their premiums will be higher.
People looking for the most coverage for the same price can purchase Type 1 ULIPs in that case. This guarantees that, upon the policyholder’s death, the beneficiaries will get the larger value, i.e., the fund value or the sum assured. Your financial demands and aspirations will determine everything.