In the current competitive business environment, sale and purchase of financial products has become a daunting task, both for the financial institutions and the customers. Insurance companies and banks are engaged in tailoring financial products to lure customers through ‘concessions and special offers’, which most of the time are hard to understand.
Anecdotal evidence reveals unfair business practices particularly by insurance companies are growing at an alarming pace. Stories of mis-selling of financial products, especially insurance policies, to the gullible customers are not new. Who can forget rampant mis-selling that took place in 2007-08 when unit linked insurance plans (ULIPs) were sold in abundance on the pretext that the money invested would double in a three years period.
That was a time when investment in banks’ fixed deposit schemes would double in over 7 years’ time. This attracted herd mentality from big as well as small investors and were later trapped in ULIP when after 2008 market bloodbath the investors lost their money, not to speak of interest which they were supposed to have earned during the period of the investment.
A lot was debated on this kind of mis-selling. But hardly a word was uttered about the bad decision of the customers and the investors, as most of the times they exhibited herd mentality. We have been targeting financial intermediaries for making money through mis-selling causing huge financial loss to the gullible investors. I am not saying the targeting was wrong, but hardly I found anyone catching hold of investors for mis-buying. Mis-selling is, of course, common but so is mis-buying.
What’s this mis-buying of financial products?
I have usually observed that savers make dozens of mistakes while buying financial products—partly because they are careless and partly because we humans find it hard to deal rationally with money. Commonly, they buy a product without understanding its features, or risks associated with the investment. An element of greed or too trusting nature also results in mis-buying of a product. Unfortunately, mis-buying is not accepted by an investor and very easily tends to pass the buck on to financial intermediaries who sell financial products.
Mis-buying owes its origin to factors like optimism, herd mentality, framing etc. It’s human nature that generally, we expect good things to happen to us – be it better market returns or finding a special person in life or building a delightful career with flying colours. Nobody expects bad things to happen. This optimism is also one of the most common traits of investors. But in financial matters, this optimism is counterproductive. Investors buy on the expectation of better returns, but without taking into consideration the negatives.
People find it useful by moving in herds for survival, but this herd mentality has disastrous consequences in financial matters. When one friend suggests a financial product, it is very hard to disagree; there’s a human tendency to do what your friends are doing. Saying ‘no’ becomes difficult in this case. Thus herd mentality is put into action. Here people do not do the due diligence and rush headlong into some product that they do not understand.
We have also observed that very often that customers are pushed into mis-buying because of the packaging of financial products by a company. This is framing and induces the customer to think that they are paying less for higher benefits which basically is not true in real sense.
How to save yourself from this kind of mis-buying?
The basic prescription to prevent mis-buying is literacy. So when you intend to buy a financial product, it’s necessary for you to do your homework before buying the product. If you are not able to understand the features of the product, don’t hesitate to consult a financial expert to understand the product.
Remember the greed and fear factor will induce you to act irrationally, even if it is against your best interest.
Is investment in Unit Linked Insurance Plans (ULIP) similar to bank Fixed Deposit (FD)?
It is a common practice adopted by many insurance agents where they target customers with a ULIP offer, describing it as good as a bank FD. They convince bank customers that ULIP is better than an FD, as it comes with insurance cover.
However, the fact is that ULIPs and FDs are two different financial products. A bank FD gives guaranteed returns and the investment horizon is for a shorter period. While as, ULIPs are market-linked products that combine investment with insurance. Here the additional benefit of insurance comes at a cost and returns are not guaranteed. There is no guarantee that the fund will generate a specific return nor is the fund value an assured amount.
Besides, this insurance product is meant to be a long-term investment. Notably, an investor is not allowed to withdraw money as ULIPs have a lock-in period of five years. An investor is usually at a loss if he/she takes exit route from the plan after the expiry of the lock-in period as costs are front-loaded and majority of the charges are levied in the initial five years.
What are the most important things you need to know before taking a plunge in ULIPs?
The basic thing is to know how a Unit Linked Insurance Plan Unit Linked Insurance Plan works. ULIPs provide life insurance coverage in addition to investment benefits. A portion of your premiums goes toward the insurance coverage, and the remaining amount is invested in equity, debt, or a combination of both. This means the returns are market-linked returns. When returns are linked to the market, the volatility is inevitable and risk of even losing capital investment cannot be ruled out.
There is flexibility in terms of the amount and frequency of premiums, as well as the investment options. You can choose between equity, debt, or a combination of both, and switch between funds as per your investment goals.
After understanding the product, you should know that ULIPs are loaded with charges and fees. You have to pay premium allocation charges, policy administration charges, fund management charges, mortality charges, and surrender charges. These charges can vary from policy to policy. Your investment will be subjected to a minimum lock-in period of five years, during which you won’t be able to withdraw your money.
Of course, ULIPs offer tax benefits under Section 80C of the Income Tax Act, allowing you to claim a deduction on the premiums paid. The maturity proceeds are also tax-free under Section 10(10D) of the Act.
Meanwhile, ULIPs offer a free-look period of 15-30 days. It paves a way for the investor to come out of the plan if he/she realizes that the policy is not suitable, by surrendering it within the given free-look period.
Disclaimer: The views and opinions expressed in this article are the personal opinions of the author.
The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.