There are 4 types of funds in a ULIP scheme. These are the Growth Fund, the Secured Fund, the Balanced Fund and the Bond Fund. The policy holder has the option of investing in one or more of the funds as per his or her choice. The policy holder also has the option of shifting (also called switching) his or her investment from one fund to another, subject to policy conditions. It is useful to know the meaning and content of the 4 funds. But before understanding the 4 funds, we need to know the investment categories of ULIPs. Continue reading after the two colored boxes below…
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The 3 categories of investments in ULIP products
There are 3 basic categories of investments where all ULIP premiums are invested. These are:
- Category 1: Investments in government, government guaranteed securities, and corporate debt
- Category 2: Investments in money market instruments such as treasury bills, inter-bank call money market, and other securities issued by banks in the short term money markets
- Category 3: Investments in shares and other equity based listed securities on the stock exchanges
A fund is defined by how much of the premium is invested in each of the three categories mentioned above. The extent of investment in each of the 3 categories also defines the riskiness of the fund.
Where Do the Funds Invest the Money?
In the Growth Fund for example most of the money is invested in Category 3 securities, that is shares, etc.
In the Secured Fund, the investments are in Category 1 (government), Category 2 (money market) and Category 3 (shares). However the investments are more in Category 1 and 2, and to a lesser extent in shares (Category 3).
In Balanced Fund, the premiums are invested in all three categories balancing the three categories depending upon the market situation from time to time.
In Bond Fund, investments are made only on Category 1 and 2. No investments are made in Category 3 (shares).
The degree of risks associated with each fund
The risks of investment in the four funds is defined by where the investments are made (Category 1 or 2 or 3) and to what extent. That is how much of the premium is invested in each of the three categories.
Growth Fund
The Growth Fund is a high risk investment because most of the investments are in shares.
Secured Fund
The Secured fund is less risky than the Growth Fund and Balanced Fund but more risky than the Bond Fund, because a large part of the investment is made in fixed income securities that are available in Category 1 and also in money market instruments of Category 2.
Balanced Fund
The Balanced Fund is less risky as compared to the Growth Fund but is more risky than the Secured Fund and the Bond Fund, because more money is invested in shares as compared to the Secured Fund and Bond Fund. A balanced Fund, in general, however does not invest as much in shares as a Growth Fund.
Bond Fund
The Bond Fund does not invest in Category 3 (shares) securities. Most of the investment is in Category 1 (government) , while some investment can also be in Category 2 (money markets).
Investment Risks of the three categories
Category 1 (government) is the least risky. A fund that predominantly invests in Category 1 is as safe as traditional endowment insurance. Category 1 is where most of the traditional endowment investments are made.
Category 2 (money markets) are subject to volatility, but the range of volatility is very low. This is also a low risk investment. The risk here is not so much whether the investment earns money, or whether the principal amount will be recovered. The risk is that of asset-liability matching. Money market instruments are primarily short term in nature, while life insurance contracts are long term in nature. Hence there is a mismatch between the maturities of the asset (money market instruments in this case) and the liabilities of maturity benefit in a ULIP policy.
Category 3 (shares) are subject to a much higher degree of volatility in the share price movements in the market. The higher degree of volatility results in higher risk.
Classification of Funds by their riskiness
Most risky: Growth Fund
Next Most risky: Balanced Fund
Next Most risky: Secured Fund
Least Risky: Bond Fund (Similar in risks to traditional endowment fund)
In our next article we shall study why people buy risky investments. Do stay tuned in. For we
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