Several individuals use insurance to secure their future. Traditionally, life insurance provides financial protection in case of an unfortunate event. However, you do not receive any returns on your investment.

Have you ever considered that there may be an option that allows you to earn returns while providing insurance coverage? A Unit-Linked Insurance Policy (ULIP) does just that. A portion of your premium is invested in different financial instruments to deliver returns.

Understanding ULIPs

As mentioned, this type of policy combines insurance coverage with investment. Some part of the premium amount is invested in market instruments such as debt, equity, or cash products to enable you to earn returns on your investments. These policies are similar to mutual fund investments where you purchase a certain number of units based on the Net Asset Value (NAV).

The insurance coverage in the plan is linked to a unit fund. In case of your demise during the policy term, your nominees receive the higher of the fund value or the sum assured. Alternatively, when the policy reaches maturity, you receive the fund value as the maturity benefits.

You need to understand the creation of a unit fund to know about the NAV. Money from several investors is pooled to build a larger investible corpus. This amount is then invested in market instruments. The corpus may be invested in debt, equity, or cash products.

The returns on such pooled investments must be divided among the several investors. To achieve this, the fund manager divides the total corpus into units that are with a definite face value. Every investor has a certain share within the fund based on his investment amount. To begin with, the value of each unit is known as the Net Asset Value or NAV.

Once the corpus is invested in the financial instruments, the fund value may rise or reduce daily based on the market performance. As a result, the NAV also increases or decreases. Below is the formula used to calculate the NAV of a fund:

NAV = Market value of the investments + Value of current assets –Current Liabilities and Provisions / Number of units as on date

The number of units is calculated before the creation of new units or redemption of existing units. Below is an example to understand more about NAV.

Example to calculate the NAV

In real life, there may be thousands of investors for a specific fund. For calculation purposes, assume there are only two investors Mr. Shah and Mr. Arora. Next, assume that Mr. Shah invests INR 80,000 while Mr. Arora invests an amount of INR 60,000.

From these amounts, certain expenses such as mortality charges, management fees, and others will be deducted. Let us assume that after the deductions for all such expenses, the contribution amounts are INR 60,000 and INR 40,000 for Mr. Shah and Mr. Arora, respectively. Therefore, the net amount that may be invested in market instruments is INR 100,000.

The fund manager creates units that have an INR 10 face value. Therefore, the number of units issued to Mr. Shah is 6000 (60000/10) and to Mr. Arora is 4000 (40000/10). The total number of units for the particular fund is 10000.

NAV = Net value of the fund / Number of units = 100000/10000 = INR 10

The fund manager then invests the total corpus in various market instruments. Because of such investment, there is a profit, and the total value of the fund now increases to INR 120,000.

NAV = 120000/10000 = INR 12

Therefore, Mr. Shah and Mr. Arora earn returns of INR 2 per unit because of the rise in the price of the investment products.

Assume that after a few years, the total value of the fund increases to INR 300,000. The NAV, in this case, will be

NAV = 300000/10000 = INR 30

A common misconception among investors is that if the ULIP NAV is high, the plan is expensive. As a result, they may avoid investing in this plan. On the other hand, a fund with a lower NAV is considered inexpensive, which may encourage you to invest in the same.

However, as seen above, NAV is only the book value of the fund after reducing related charges and expenses. It is neither inflated nor misrepresented. The NAV reflects the fair value of the various investments if all these are sold on a particular day. Therefore, a lower or higher NAV does not have much significance and you must not base your investment decision solely on this parameter.

The pooled funds are invested in equities, debt, and cash products. If you are risk-averse, you may opt for plans that invest in debt products. This ensures you receive guaranteed lower returns. However, if you are willing to assume higher risks to earn greater returns, equity funds are an excellent option. It is important that you take the time to research the different plans offered by various insurers to make an accurate decision.

The ULIP performance depends on the increase or decrease in the market value of the investments. Therefore, the NAV changes as per the market performance and changes almost daily. The fund managers calculate the NAV at the end of the market time and the updated value is posted on the website. This allows you to conveniently track the NAV and make your investment decision.

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SIMPLE TAX INDIA: Do You Know How to Calculate ULIP NAV?
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