AMFI Registered Mutual Fund Distributor | SEBI registered Investment Adviser
FSM LOGO

                    


titl_l_gif
Funds and Personal Finance
title_r_gif
Share | Email Print more
ULIPs: Investment or Insurance?
February 26, 2010

We take a look at ULIPs in comparison with mutual funds based on some common parameters to understand the differences between ULIPs and Mutual Funds.


Author : FSM Content Team



Untitled Document

 

According to IRDA, “ULIP is an abbreviation for Unit Linked Insurance Policy. A ULIP is a life insurance policy which provides a combination of risk cover and investment. The dynamics of the capital market have a direct bearing on the performance of the ULIPs Remember that in a unit linked policy; the investment risk is generally borne by the investor.”

However, ULIPs are largely sold as solely investment products. So strong is their positioning that a larger share of retail investors’ money enters the market through ULIPs than through pure investment products like mutual funds. This article takes a look at where we might be getting it wrong.

ULIPs or Unit Linked Insurance Policies, are, as the name suggests, insurance policies with a portion of the premium invested in the market. As only better informed retail investors would know, this is not principally different from a traditional insurance policy. Traditional insurance policies also invest a part of the premium in the market (that’s where our bonuses accrue from); the biggest difference here is that with a ULIP, the investor is aware of how much of his/her premium is invested in the market and gets to choose between fund options that the policy premium will be invested in. Many additional flexibility and control-related features have also been introduced with ULIPs which do not apply to traditional policies – but again, the benefits would be in comparison to other insurance products.
Why then are ULIPs sold primarily as an investment vehicle?  Why are they often compared with mutual funds instead of other insurance options?  We believe that they are two different products, serving different investor needs and should not be sold as alternatives. We take a look at ULIPs in comparison with mutual funds based on some common parameters to understand these differences
.

Objective

The first question that an investment expert would ask you while evaluating product options is “What is your investment objective?” All available products in the market are structured to meet a specific investor need – and the costs, tenure, risk, etc., of that product are structured accordingly.
ULIPs are an insurance product, meant primarily to provide you with an adequate risk cover. Mutual funds are an investment product designed for wealth building. The fact that ULIPs may also provide growth in capital should not confuse you. In fact, a rule that a lot of expert investors follow is that the simplest products usually suffice to meet our objectives, are easy to understand and manage, and are the most cost effective.
Considering cost and liquidity parameters,  ULIPs may not be  the most appropriate investment option if you are seeking equity market benefits.

 

Cost

When investing in a product there are two ways of evaluating the costs involved:

  1. How much of what I am putting in will be invested for me?
  2. What are the management fees, hidden charges, commissions that I may not be aware of?

Mutual Funds

ULIPs

In mutual funds, 100% of your investment amount goes to work for you. Until early 2009, an entry load was usually levied by the fund houses, but SEBI has now mandated that mutual funds can not charge entry loads.

Premium Allocation Charge is deducted from the premium you pay every year. It includes costs for policy creation, underwriting, medical tests, and distributors’ commissions, etc. Premium allocation charge is usually much higher in the initial 3 years than the rest of the policy’s life. Some existing policies deduct as high as 60 to 70% of premium initially – so effectively only 30 to 40% of your premium would be invested.

On the invested funds a certain percentage of fees are charged which includes the annual fund management fee, brokerage paid out to distributors, custodian charges, etc. In any year, all these charges put together cannot exceed 2.5% of the fund value.

Fund Management Fee, Policy Administration Fee and Mortality Fee are deducted on a monthly basis from your invested fund. Some insurers deduct fund management fee on a daily basis.
Apart from these basic charges, additional charges may be levied in case of guaranteed returns, additional riders, switches, top up premiums, partial withdrawals, etc.

Most AMCs levy an exit load if you redeem your mutual fund within a year.

Surrender Charge is levied on premature redemption of your policy units. Generally, surrender is possible only after at least 3 years of policy, and surrender charges are levied by some insurers for as long as 10 years. Recent amendments by IRDA regulate that no surrender charge should be levied from year 6, but this would apply only to new policies.

 

IRDA recently stipulated that beginning 2010 all costs on ULIPs have been capped at 3% for policies up to 10 years and 2.25% for policies more than 10 years. However, please note the following:

  • This cap does not include cost of “guarantees” on your policy. All policies offering “guaranteed returns” carry an additional cost which is not included in the cost cap.
  • Insurers can still charge you more in the initial years and reduce the charges in the later years. Total cost will be calculated across life of policy so costs can be heavier initially and averaged down in the latter part of the term.
  • This cap applies only in cases of policies held till maturity. So if you surrender your policy mid-term, you will almost definitely incur costs exceeding the IRDA cap.

In some policies that we researched, we found that in the first 5 years of the policy, the total costs (in rupee terms) range between 22% and 16% of the premium paid. There are ULIPs with much higher font-end loading.

 

Liquidity

While an investment may mature at a much later date, it becomes liquid from the time it allows you to exit the investment at minimal or zero cost/penalty. Ease of redemption and time taken to get proceeds are also taken into account.

Mutual funds offer a range of products with liquidity to suit different investor needs, with standard and transparent regulations for redeeming your investment. Liquid funds offer complete liquidity (you can invest and redeem in a matter of days), while most equity and balanced funds allow redemption after a year of investment with no exit load. This practice is mainly to discourage investors from redeeming within a short period of time as equity is for long-term investing.

For investors looking at medium to long-term investment horizons, there are funds like long-term bond funds, FMPs (fixed maturity plans), closed-ended equity funds, etc., which have specified lock-in periods. ELSS funds (equity linked savings schemes) are tax-saving investments under section 80C and have a lock-in period of three years.

With ULIPs, liquidity is not a very transparent issue. You need to evaluate the following:

  • After how many years is surrender of the policy allowed
  • After how many years can you surrender the policy at zero surrender charge
  • At what point does surrendering your policy incur you the least loss [As explained earlier, in ULIPs costs are heavier in the earlier years of the policy, meaning the yield on your investment can be negative also.]

 

As an example, we present the following Generic Benefit Illustration we found for the SBI Life - Smart ULIP on the SBI Life website. The insured is a 40-year old male, premium is Rs. 50,000 annually and the policy term is 10 years, with premium payable for 5 years.

The illustration assumes a gross return of 10% pa.

Policy Year

Annual Premium

Pr. Allocation Charge

Amt Invested

Policy Admin Charges

SA Related Charges

Fund Mgt Charges

Mortality Charges

Total Charges

Service Tax

Addn to Fund (if any)#

Fund  Value at end of year

Surrender Value

1

50,000

7,500

41,727

720

1,250

626

386

2,982

1,081

3,844

42,281

33,824

2

50,000

2,500

47,242

720

1,250

1,343

325

3,638

633

8,551

94,061

82,773

3

50,000

2,500

47,242

720

1,250

2,120

237

4,327

704

13,653

150,183

136,666

4

50,000

2,500

47,242

720

 

2,962

124

3,806

651

19,323

212,549

208,298

5

50,000

2,500

47,242

720

 

3,897

 

4,617

734

25,470

280,168

280,168

6

 

 

 

720

 

4,203

 

4,923

508

27,474

302,211

302,211

7

 

 

 

720

 

4,534

 

5,254

542

29,642

326,057

326,057

8

 

 

 

720

 

4,891

 

5,611

578

31,987

351,855

351,855

9

 

 

 

720

 

5,278

 

5,998

618

34,524

379,763

379,763

10

 

 

 

720

 

5,697

 

6,417

661

37,269

409,954

409,954

#: This figure denotes the 10% growth in the fund value.

 

Points to note in this illustration:

  • The surrender value is lesser than the fund value in the first 4 years – indicating that there is a surrender charge for first 4 years.
  • The surrender value is less than the premium invested up to that point for the first 3 years – indicating that the costs exceed the yield of the fund.
  • If you surrender in less than 4 years, you incur a loss.
  • Even if you surrender in year 5, your total yield works out to be 12.07% - on an annualized basis this is much lesser than what you would make in a fixed deposit for 5 years.

ULIPs are therefore a long-term product and generally start to yield returns comparable to market level only in the second half of their term.

 

 

Performance

In this section, we keep the structural changes between the two products aside and look purely at the performance of their funds. In ULIPs, like in mutual funds, the “investible premiums” of all policy holders are collected in a fund and invested in the designated market instruments by a professional fund management team.

For the purpose of our comparison, we have taken the funds underlying some selected ULIPs, and compared their performance with mutual funds, bearing in mind that the asset allocation of the ULIP fund and mutual fund being compared is similar*.

 

ULIP Fund

Performance (%) #

Mutual Fund

Performance (%) ##

6m

1Y

3Y^

6m

1Y

3Y^

HDFC Life Defensive Managed Fund

5.8

25.7

10.6

HDFC MIP Long Term Plan

6.5

33.6

11.7

ICICI Prudential Life Maximiser Fund

6.86

81.3

9.6

ICICI Prudential Growth Fund

10.6

73.8

8.4

Reliance Life Pure Equity Fund

5.5

76.2

NA

Reliance Vision Fund

13.0

90.0

9.8

* Following is the asset allocation as defined by issuers for the ULIP funds as well as the mutual funds compared here:
HDFC Life Defensive Managed Fund: Money Market and Pub Deposits 0-20%; Govt Securities and Bonds 50-85%; Equity15-30%
HDFC MIP Long Term Plan: Equity: 0-25%; Debt: 75 -100%
ICICI Prudential Life Maximiser Fund: Equity: 0-100%
ICICI Prudential Growth Fund: Equity: 0-95%; Debt: 0-5%
Reliance Life Pure Equity Fund: Equity 60-100%; Debt 0-40%
Reliance Vision Fund: Equity: 60-100%; Debt: 0-40%
---------------- -------------------------------------------------------------------------------------------------------------------------------------------
# Performance as at 23 Feb 2010; Source: Data available on insurer websites
## Performance as at 23 Feb 2010; Source: iFAST compilations
^ Returns for more than 1 year have been annualized.

 

Conclusion

Our objective in this article is not to negate the use of any product, nor is it to prove that mutual funds are superior in all respects to ULIPs. In fact, we say that the two should not be compared, since they serve different purposes and are structurally very different.

For investors with no previous experience with investing, and existing relationships with insurance agents, ULIPs probably are an easy sell. However, with availability of easy and low cost investment products like mutual funds, it is time to educate ourselves, understand our options and choose products based on our need.

If you are looking for insurance cover, intend to retain and maintain that cover over a long-term horizon and would like to have better visibility into where your premium goes to work in the market, a ULIP could be your choice. That again should be decided by looking at other available insurance products. But if you’re looking for an investment in the market with the intention of wealth creation, we recommend that you go in for an investment product, like an equity mutual fund.

IRDA FAQs on ULIPS:
http://www.irdaindia.org/FAQs/faq_ulips221007.pdf

 

 

 


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


Comments (0) | Comment on this Article
 (Click on Comments/Comment on this Article to show or hide comments/post a comment)
USEFUL LINKS
Recommended Funds
Recommended Portfolios
Chart Centre
Risk Profiler