What is ULIP? How it works?

Unit linked insurance plans -ULIP are different from traditional insurance plans and are linked with stock market. ULIP is basically a combination of insurance as well as investment. A part of the premium paid is utilized to provide insurance cover to the policy holder while the remaining portion is invested in various equity and debt schemes. The money collected by the insurance provider is utilized to form a pool of fund that is used to invest in various markets instruments (debt and equity) in varying proportions just the way it is done for mutual funds.

 ULIP policy holders are also allotted units and each unit has a net asset value (NAV) that is declared on a daily basis. The Premium paid in unit linked insurance plans are subject to investment risk associated with capital markets and the unit price of the units may go up or down based on the performance of investment fund and factors influencing the capital market  and the policy holder is responsible for his decisions.

How does ULIP work? Why initially fund value is lower than invested amount?

Life insurance is a long term contract; we will get the benefits over a period of time not in three years or five years. Whether it is a traditional plan or unit linked plan we will not get returns in short period. Because insurance plans are having more charges in initial years and thereafter. Though we will get better returns, while we stay in long time. Normally in unit linked insurance plans the premium paid by you is not the amount that gets invested. There are some front charges and other charges. The following charges get deducted, some initially and some during the policy term.

Premium Allocation Charges: These are deducted from the premium amount paid.

Policy Administration Charges: These charges are for policy maintenance and deducted from units in the policy.

Fund Management Charges: For managing the fund, these charges are also deducted from the units.

Cost of Guarantee: In Best Ulip Insurance Policy which offer minimum guaranteed amount or NAV, there is cost of guarantee which is deducted from the total units.

Mortality Charges: These charges are for the life cover and deducted from total units in the policy.

Miscellaneous charge: these charges are for policy revival are additional requests like premium re direction, partial withdrawal.

After the charges are deducted, the premium will be used to buy fund units. The returns will depend on the performance of chosen fund.

Source: http://nexttag.blogspot.in/2013/05/what-is-ulip-how-it-works.html