Serving as one of the preferred financial tool for both investment and insurance, ULIPs are one of the most popular investments made in today’s time. Moreover, they offer an array of tax benefits and a flexibility in ULIP investments as per your specific financial goals and priorities. However, most investors are unaware that ULIP plans can also be placed into two distinct categories - Type 1 and Type 2. While both of these categories of ULIPs have their own advantages, it is important to first understand how they operate and how they can specifically benefit your financial goals. Here is a closer look at Type 1 and Type 2 ULIPs, their differences and their pros and cons.
What is ULIP?
Before we delve into the types of ULIPs, let us first review the question of "What is ULIP?" and how it is beneficial for the average investor. A Unit Linked Insurance Plan, or ULIP, is an investment option, which offers the policyholder the dual benefit of investing in either equity funds or debt funds (or both), while providing life insurance coverage. Policyholders pay premiums, a part of which is channelized into market-linked instruments, and the remaining amount is used to provide life insurance cover by the insurance companies.
ULIP plans offer a wide variety of benefits to investors. Firstly, they offer investors immense flexibility in choosing funds as per their specific financial goals. You can invest in high-risk equity funds, medium-risk fixed income funds or even low-risk liquid funds, all managed by professional fund managers. Over time, as your goals and risk appetite changes, you can also switch between your choices of ULIP funds. Apart from this flexibility, ULIPs offer an opportunity for inculcating the habit of disciplined savings, receiving insurance coverage and availing various tax benefits.
Types of ULIPs
While ULIPs have increasingly emerged as a popular investment tool, many potential investors are unaware that most ULIPs can be differentiated into two categories - Type 1 and Type 2 (often referred to as Type-I and Type-II). Let us understand these two categories of ULIPs in detail –
1. Type 1 ULIP
In the event of the unfortunate demise of the policyholder, the insurance provider of a ULIP Type 1 plan pays either the sum assured or the fund value of the ULIP plan to the beneficiaries. Whether it is the sum assured or the fund value that is disbursed as death benefit depends on which of them is higher in value.
For instance, let us assume that you have paid premiums for your ULIP Type 1 with a sum assured of Rs 50 lakhs. Meanwhile, your investment fund value of your ULIP has also been generating returns. If at the time of your demise, your fund value is Rs 30 lakhs, then the death benefit received by your beneficiaries for your ULIP plan would be the higher of the two i.e. Rs 50 lakhs. However, if the fund value amounts to, say Rs 80 lakhs, this amount will instead be disbursed as death benefit.
2. Type 2 ULIP
In the event of the unfortunate demise of the policyholder, the insurance provider of a ULIP Type 2 plan pays the sum assured of the ULIP plan to the beneficiaries. Hence, the death benefit disbursed is the sum assured under the ULIP.
Taking the example stated above, let us assume that at the time of your demise, your sum assured is Rs 50 lakhs. The death benefit disbursed by the insurance provider to your beneficiaries would be 50 lakhs.
Difference between Type 1 and Type 2 ULIPs
ULIP plans differ based on features such as the type of insurance coverage offered, the type of funds, the type of premium payment options, and the investment objectives for the ULIP. In case of Type 1 and Type 2 ULIP plans, the distinction is made in terms of the final death benefit paid out by the insurer. This leads to certain marked differences between the two types of ULIP policies.
Firstly, as we can understand from the examples stated above, there is a difference between how the death benefit is calculated. In the case of Type 1 ULIP plans, the sum assured and fund value is compared and the higher of the two is deemed the payout. In case of Type 2 ULIP plans, the sum assured under the policy is deemed the payout.
Secondly, the two types of plans differ in terms of the "sum at risk". In case of Type 1 ULIP, the insurer would need to pay either the sum assured or the fund value as death benefit, depending on which one is higher. This means that each year, as your fund value grows, the sum at risk for the insurer keeps decreasing.
On the other hand, for Type 2 ULIP, the insurer has to pay the sum assured as death benefit. Therefore, the sum at risk for the Type 2 ULIP remains constant, year after year, even as your fund value grows and becomes higher than the sum assured.
Which One Should You Choose and Why?
While the difference between the definition and features of Type 1 and Type 2 ULIPs is clear, the question that remains is "What is the ULIP plan that is suitable for you?" The answer to this question is variable and depends on your financial goals and priorities.
At first glance, Type 2 ULIP plans might seem better since they come with greater benefits. However, it is important to note that since the risk borne for Type 2 plans is higher for the insurer, they may come with higher mortality charges than Type 1 plans.
With the wide range of benefits and flexibility that ULIPs offer, they serve as one of the preferred financial tool for a variety of investors. Whether you opt for Type 1 or Type 2, your choice of ULIP investment can always be customised to suit your specific financial requirements and goals for years to come.