Will ULIP Debt Funds Offer Better Returns with a Potential RBI Rate Cut?
Reserve Bank of India (RBI) is likely to calibrate key interest rates downward in line with the US Federal Reserve by the year-end. The US Fed had reduced key interest rates by 50bps in September, based on which expectations had surged for an RBI cut also. Speculations about RBI, follow as the central bank winded up its three-day monetary policy committee already.
Against this backdrop, life insurance companies are positioning their debt-oriented unit-linked insurance plans (ULIPs) to catch whatever advantage they can get from a rate cut. Currently, there are 24 life insurers offering 135 debt fund options, seeking to meet the individual investment needs of policyholders.
What Are ULIP Debt Funds?
ULIPs offer the policyholder the facility to invest in different funds depending on the type of plan that one desires for the fulfillment of specific financial goals and risk appetites. ULIPs, similar to mutual funds, provide equity, debt, and balanced funds with liquid, short-medium and long-duration debt funds.
While ULIPs, of course, come in multiple varieties, most financial advisors still advise against insurance investing as it traditionally came with a high-cost structure. Premium allocation charges, policy administration charges, mortality, and fund management charges have been discouraging some investors from investing in ULIP policies for years. However, in the recent past, many newly launched ULIP products have minimized these charges to lure policyholders. For instance, a good number of companies have ULIPs with no allocation charges as they invest 100% of the premium into the funds while charging only very minimal fees for it. Mortality charges, however, continue to be accrued and, if the policyholder does not have any need for life cover, would decrease the chances of returns.
Reasons Why ULIP Debt Funds Are Now More Attractive?
ULIP debt funds are also made more attractive due to changes in tax law. The Finance Bill 2023 deprived, of debt mutual funds, indexation and long-term capital gains tax exemptions, thereby aligning the returns from them with the same generally available from banks in respect of their fixed deposits (FD). ULIP maturity proceeds are exempt subject to certain conditions. The maturity amount is tax-free if the annual premium under the ULIP does not exceed Rs.2.5 lakh and if the policy has completed its five-year lock-in period. ULIPs might therefore seem more attractive to small investors than debt mutual funds and FDs.
However, the ULIP proceeds cease to be tax-exempt and attract capital gains tax if all ULIP policies’ total annual premiums exceed Rs.2.5 lakh. In that respect, this proviso has served to make ULIP debt funds more accessible for small investors who are well within the Rs.2.5 lakh premium limit.
On the flip side, ULIP investors have fewer fund choices than debt mutual funds. Debt mutual funds offer up to 18 sub-categories, thereby providing flexibility to the investor to choose a fund of preference.
Switching Facility in ULIPs
A major benefit of ULIPs is the flexibility of switching between equity and debt funds. The policyholder will be allowed to switch funds without facing the capital gains tax or exit loads up to maturity. It gives an investor an opportunity to rebalance the portfolios and adjust the risk profiles based on the market conditions. Although most of the ULIPs provide free switches, some insurers take a modest charge for the facility.
However, the investors in mutual fund schemes can redeem units and invest in other funds, which might be performing better if the fund one has invested in is not doing so well. ULIP investors are tied to the insurance company’s funds and management with ULIPs. Sure, they can surrender a ULIP, but only after waiting till the five-year lock-in period.
Should Investors Invest in ULIP Debt Funds?
According to experts, debt fund allocation in ULIPs should be in line with long-term financial goals. In other words, buying a ULIP only for some expected interest cuts may not be a wise strategy since “insurance is generally a long-term commitment”. According to the expertise, rebalancing the debt portion of investments in ULIPs at periodic intervals should be done in accordance with changes in market conditions and risk profiles. This ensures that, over time, the portfolio remains stable and safe.
Categories of ULIP Debt Funds
ULIP debt funds are categorized as liquid, ultra-short duration, money market, short-duration funds, long-duration funds, medium-to-long debt funds, and government bonds. Specifically, the short-duration funds invest in debts with three to five years of residual maturity, thus generating revenue both through accruals and duration strategies.
Till September 30, 2024, the Edelweiss Tokio Life-Bond Fund, a short-duration fund, had invested nearly 69% of its corpus in corporate bonds and 23% in government securities or G-sec. The biggest long-duration bond fund by size was ICICI Prudential Life-Protector Fund II, which had about 54% of its corpus invested in G-sec and the remaining 42% in corporate bonds.
Though ULIP debt funds may appeal more in an environment of falling interest rates, investors would do well to weigh all of this against their long-term goals, tax implications, and the flexibility of fund options before making a decision.
