Few days ago, two of my friends, one in corporate aged 50 and the other in Defence Services aged 35, came to me and said that of late an insurance agent has been pressing them to buy Unit Linked Insurance Plans (ULIP). He is giving the logic that Budget 2018 proposal to re-levy the long term capital gains (LTCG) tax on MF has made them less attractive vis-à-vis ULIP. I told them to let me carry out an objective assessment and then put across both these products. The assessment transpired as follows:
MF – A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s investments and attempt to produce capital gains and/or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.
ULIP – It is a combination of insurance and investment. As a single integrated plan, the investment part and the protection part can be managed according to specific needs and choices. As a structured life insurance product, this provides risk cover for the policy holder along with investment options to invest in any number of qualified investments such as stocks, bonds or mutual funds. Here policyholder can pay a monthly or annual premium. A small amount of the premium goes to secure life insurance and rest of the money is invested just like a mutual fund does. Policyholder goes on investing through the term of the policy – 5, 10 or 15 years and accumulates the units. ULIP offers investors options that invest in equity and debt. An aggressive investor can pick equity oriented fund option whereas a conservative one can go with debt option.
Ø Costs – Until 2010 the cost structure unequivocally favoured the MF that only levied Total Expense Ratio, and entry/exit loads whereas ULIP levied multiple charges like premium allocation, policy administration, fund management, surrender and mortality. While the MF charges aggregated to about 1.5 to 2.25%, the ULIP went as high as 25 to 30% in the first year and reduced thereafter. Consequent to directions of the insurance regulator (IRDA), the maximum reduction in yield, excluding mortality charges, due to ULIP costs are now capped in the first 5 years at 4%, from 5 to 10 years at 3% and from 10 year onwards at 2.5%. Moreover, the costs of ULIP are front-loaded (mostly levied in the first five years of the investment) whereas those of MF are even-loaded (levied regularly and evenly through the entire duration).
Ø Returns – MF have consistently delivered better returns than ULIP in all time horizons. It is only after 12 to 15 years that ULIP come at par with MF for returns. A comparative chart by Advisorkhoj proves this point:
|Category||Top Performing MF||Top Performing ULIP|
|Large Cap equity||13 – 14 %||11 – 14%|
|Flexi cap Equity||14 – 16%||8 – 9%|
|Small/Mid Cap Equity||14 – 18%||13 – 15%|
|Balanced||13 – 14%||10 – 13%|
|Debt oriented Hybrid||10 – 12%||10 – 11%|
|Income||8.5 – 9.5%||8.5 – 9.5%|
Ø Cost-Return Relationship – The ULIP have equitable cost for investment in debt and equity oriented schemes. However, the TER charged by MF is more in case of equity oriented funds and less in case of debt funds. This implies that in accordance with the lower returns of a debt MF, an investor pays lesser investment cost and pays more for investing in equity MF that give higher returns. However, in ULIP he pays uniform cost for investing in debt and equity schemes, which is not beneficial for the investor.
Ø Taxation – This is where the ULIP scores heavily against the MF after the recent budget proposal. Earlier, the taxation policy was slightly biased in favour of ULIP since they provided the Sec 80C relief to the investor, which MF, except ELSS, did not provide. Moreover, ULIP offered tax free returns after staying invested for 5 years whereas only equity MF gave tax free returns after one year lock in. The tax free advantage of ULIP extends beyond the equity funds to the fixed income space, which is not the case in MF.
Ø Liquidity – The ULIP are less liquid than MF since they have a five year lock in period and permit only partial withdrawal after that period. In the case of MF only the ELSS have a three year lock in period. In other MF the investor can redeem fully or partially after paying an exit load of about 1 to 1.5%, if redeemed within one year from the date of investment.
Ø Flexibility – This has two aspects. The first is flexibility to redeem when required that is more in case of MF as discussed under liquidity. The second aspect is switching funds or stopping investment, which is afforded more by MF than ULIP. In MF, one can switch investment at will between different schemes of the same Asset Management Company (AMC) or even switch to other schemes of different AMC. However, this is not possible in the case of ULIP where one is allowed to switch only between offered schemes of the same AMC.
Ø Transparency – MF are relatively more transparent since they are more widely tracked by numerous agencies vis-à-vis ULIP. Moreover, charge structure of ULIP is fairly complicated and some of the charges levied by ULIP are not built into the NAV, unlike the MF, but are deducted directly from the units held.
Ø Choice – The choices available in MF are far more than those available in ULIP. There are 42 AMCs with over 2400 schemes available in MF, whereas ULIP count runs only into a hundred plus. Besides choice, it is easier to invest online in MF than ULIP, once KYC is done, as ULIP requires more documentation and insurance being an insurance product.
Ø Insurance Cover –The investor must understand that the insurance cover provided by ULIP is inadequate. Ideally, an earning member must insure himself for ten times his annual income. However, ULIP provides life cover that is only 10 times the annual premium, which is far lesser than annual income. Moreover, ULIP certainly does not cover deaths due to war and most of them also exclude death due to terror or terror related activities. Therefore, read the fine print (especially defence and paramilitary personnel) for exclusions before signing on the dotted line.
Ø Wealth Creation – ULIP is normally sold as a wealth creation instrument. One must remember that investment prudence suggests mixing up investment and insurance in one product is less productive from wealth creation point of view than separate investment (MF) and insurance product (term plan). The wealth creation normally takes place after 12 to 15 years of investment when the ULIP starts generating higher returns with lower costs.
Ø Age of Investor – Lot of agents incorrectly sell ULIP to retired or retiring people by saying that they must take an insurance product since their corporate or group insurance policies will cease after their retirement. Normally agents selling ULIP as an insurance product entice investors of all age groups by quoting tax free returns, 10 fold insurance cover of the premium and its wealth creation ability. ULIP is a reasonably good product for young and high tax bracket investor. Entering ULIP after 50 or 55 years of age has some distinct disadvantages. First, you require regular cash flow to pay regular premiums or lump sum investment for one time premium. Second, the lock-in period of 5 years restricts your flexibility and usability of the funds. Third, wealth creation takes a long time (12 to 15 years) and thus may not be feasible for aged investors.
Ø Free Look Period – By and large if you are not satisfied with the terms and conditions of the policy, you can return the policy document to the Company for cancellation within 15 days from the date of receipt of the policy document or 30 days from the date of receipt of the policy document, if the policy is purchased through distance marketing.
Ø Policy Surrender – Normally during the first five policy years, if you surrender the policy, the Fund Value including top-up fund value, if any, after deduction of applicable discontinuance charge, shall be transferred to the Discontinued Policy Fund (DP Fund). You or your nominee will be entitled to receive the DPF Value, on the earlier of death or the expiry of the lock-in period. Currently the lock-in period is five years from policy inception. However, on surrender after completion of the fifth policy year, you will be entitled to the fund value including top-up fund value, if any.
Ø Partial Withdrawal – In general partial withdrawals are allowed after the completion of five policy years and on payment of all premiums for the first five policy years. You can make unlimited number of partial withdrawals as long as the total amount of partial withdrawals in a year does not exceed 20% of the Fund Value in a policy year. The partial withdrawals are free of cost. Partial withdrawals and switches are not allowed during the settlement period.
Ø Exit Load – In case you decide to exit fully or partially, before one year then you are liable to pay exit load that is charged at the time of redeeming (or transferring an investment between schemes). The exit load percentage is deducted from the NAV at the time of redemption (or transfer between schemes) and this amount goes to the scheme.
Ask these Questions Before Investing?
Ø What is your risk appetite?
Ø What are your financial goals?
Ø Do you need insurance cover?
Ø What is your investment horizon?
Ø Do you clearly understand the complicated structure of ULIP?
Ø Can you organize regular and sustained cash flow to pay your premiums?
Ø Are you an active investor to switch within the structured ULIP products?
Ø Are you willing and equipped to continue the ULIP until its maturity or you will be forced to exit early?