Introduction
ULIPs are Unit-Linked Insurance Plans, i.e. insurance schemes where-in the underlying assets are linked to the stock market rather than government bonds or the performance of the insurer. These are increasingly popular, given the ability to combine the tax saving benefits of insurance at smaller values, with the higher return profile of market-linked investments compared to traditional insurance endowment and savings schemes.
In the last year, ULIPs made up almost a third of the life insurance market by premium value and policies sold. Amongst private insurers, ULIPs form an even higher proportion of the business, for example at HDFC Life it’s 35%, at SBI Life and ICICI Prudential ULIPs form just over 50% of the portfolio. Life insurers offer unit linked plans for savings and investing, as well as in some cases for specific purposes such as annuity or pension products or for children's plans.
You may have wondered, “Can I take a loan against my ULIP?” Whilst the Insurance Act prohibits life insurers from offering loans against ULIPs, banks and non-banks are often willing to lend against ULIPs. Unlike mutual funds, in which an investor can choose to exit as they please, ULIPs are fixed term contracts which attract penalties for early exit and have a five year lock-in period. Thus, leveraging these unit-linked policies when liquidity is required during the term of the ULIP is a smart financial solution for policyholders.
Understanding Unit-Linked Insurance Plans (ULIPs)
ULIP insurance policies are intrinsically investment portfolios, with the added benefit of life cover over the term of the insurance plan. A small proportion of the premiums paid are allocated to the life insurance cover and any riders selected, and the majority of the premium is invested in a fund selected by the policyholder. Most life insurers offer ULIPs, with the exception of some digital only players such as Acko and Digit that are focussed exclusively on group and term life cover rather than savings.
Investment Options: Most life insurers offer policyholders multiple funds to choose from based on their risk appetite and desired returns. These options range from pure equity to pure debt and hybrid funds in between. Policyholders can choose to split the premiums paid across multiple funds or invest the entire amount in one fund.
Fund Value: The portfolio will therefore have a value based on the net asset value (NAV) of the underlying funds. Note that the value of the fund is based on the current value of the invested monies, and will not include the amounts that were paid towards the core premium, riders or tax.
Tax treatment: In budget 2025, the Finance Minister has clarified that ULIPs with annual premiums exceeding INR 2.5L per annum would be taxed as capital gains, i.e. at a long term capital gains rate of 12.5% if held for more than 1 year. For ULIPs with annual premiums of less than INR 2.5L, gains are tax exempt, making them an attractive option for potential investors.
Riders: Policyholders can choose to add riders to their ULIPs - these are additional insurance coverages for various scenarios such as critical illness, partial or complete disability, accidental death, etc. Such riders typically offer additional benefits to the family or waive premiums in the case the life insured in incapacitated owing to one of these scenarios.
Policy Term: ULIPs have a minimum term of 5 years, as these are meant to offer long term protection and savings. Most plans offer terms between 7 years and 30 years, but the options available vary by plan and life insurer.
Key Considerations when Taking a Loan Against ULIPs
So, what is a loan against policy? These are loans where-in your policy is pledged to the lender as collateral. Whilst many banks and non-bank finance companies offer loans against ULIPs, there are various considerations that determine ULIP loan eligibility and value. Whilst these are specific to each lender, the broad parameters are as follows:
- Surrender Value (SV): Loans are offered against the Surrender Value or Net Asset Value at the time of the loan application. The loan value offered is typically a proportion of the surrender value, with loan to value (LTV) ratios ranging from 50% to 90%.
- Underlying Asset: The LTV ratio varies based on whether the underlying asset is debt or equity. For pure equity funds the LTV could be capped at 50-60% whilst for pure debt funds, the LTV could go up to 90%, depending on the risk appetite of the lender.
- Lock-in Period: All ULIPs have a mandatory 5 year lock-in period. This means that even if a loan is delinquent, a lender can only recover from the asset after the end of the lock-in period. Which year the policy is in against the 5 year lock-in can also have an impact on the LTV ratio or the interest charged.
- Other Considerations: Lenders typically restrict fund switching during the term of the loan to ensure that they are not exposed to higher volatility than planned for.
Once the policyholder and lender have come to an agreement on the loan value and terms, the policyholder will request the insurer to assign the policy to the lender and the loan can be disbursed.
Why choosing a Loan Against ULIP is a Smart Financial Decision
Given that ULIPs are fixed term contracts with a five year lock-in period, accessing funds tied up in a ULIP before the plan’s maturity is difficult, could incur penalties, has an impact on the returns of the plan and the insurance coverage. Loans against ULIPs offer an efficient alternative to access funds whilst keeping coverage. Let’s explore a few scenarios:
Case #1: Policyholder requires funds during the lock-in period
During the first 5 years of the ULIP term, a customer cannot withdraw their funds. If they have a financial exigency they may allow the policy to lapse - i.e. stop paying premiums or they may surrender the policy. In both cases they lose any life cover, and the funds invested to date get moved to a Discontinuation Fund, where they earn a fixed return of 4% per annum. They could also incur a discontinuance charge up to INR 6,000, depending on the fund value.
To access funds during this period, taking a loan against the ULIP existing fund value is a smarter financial decision than taking unsecured personal loans which are typically more expensive. It’s also best to keep the policy active, where possible, to avoid additional charges and reduced returns from the discontinuation fund.
Case #2: Policyholder requires funds after the lock-in period
Post year 5 of the ULIP term, a customer in need of funds could choose a partial withdrawal, whilst continuing to keep the policy active. Whilst each insurer and plan could have different rules, the withdrawals typically cannot exceed 20% of the overall fund value in a given year. This is a good option to access liquidity whilst ensuring that insurance coverage continues. The other option is to surrender the policy, and end any coverage benefits.
For those in need of more than 20% of the fund value, taking a loan against the ULIP is an effective and affordable way to access liquidity whilst keeping insurance cover active.
Conclusion
ULIPs are great financial instruments to build wealth whilst ensuring coverage for loved ones in the case of unfortunate events that impact a breadwinner over the medium to long term. Yet, over this period, life can sometimes throw us curveballs that create the need for short term liquidity. ULIPs are not intended to also offer short term fund requirements, but are assets that can be utilised as collateral to access affordable credit, or loans against ULIPs.
Taking loans against ULIP policies ensures access to funds without disrupting long term financial goals, and has the added benefit of building credit scores where they don’t exist or are low. A number of lenders offer affordable credit against ULIPs from LIC, SBI Life, ICICI Prudential Life, Axis Max Life, Tata AIA, HDFC Life, Bajaj Allianz Life, Aditya Birla Sunlife as well as other life insurers. Reach out to Mera Kal if you would like to enquire about your specific ULIP case, or would like to understand more about taking a loan against your ULIP.