Comparision Between MF and ULIPS

7/29/2019 Comparision Between MF and ULIPS

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COMPARISON BETWEEN ULIPS AND MUTUAL FUNDS:

Unit Linked Insurance Policies (ULIPs) as an investment avenue are closest to mutual funds in

terms of their structure and functioning. As is the cases with mutual funds, investors in ULIPs

are allotted units by the insurance company and a net asset value (NAV) is declared for the same

on a daily basis.

Similarly ULIP investors have the option of investing across various schemes similar to the ones

found in the mutual funds domain, i.e. diversified equity funds, balanced funds and debt funds to

name a few. Generally speaking, ULIPs can be termed as mutual fund schemes with an insurance

component.

However it should not be construed that barring the insurance element there is nothing

differentiating mutual funds from ULIPs.

Points of difference between the two:

1. Mode of investment/ investment amounts

Mutual fund investors have the option of either making lump sum investments or investing

using the systematic investment plan (SIP) route which entails commitments over longer time

horizons. The minimum investment amounts are laid out by the fund house.

ULIP investors also have the choice of investing in a lump sum (single premium) or using

the conventional route, i.e. making premium payments on an annual, half-yearly, quarterly or

monthly basis. In ULIPs, determining the premium paid is often the starting point for the

investment activity.

This is in stark contrast to conventional insurance plans where the sum assured is the

starting point and premiums to be paid are determined thereafter.

ULIP investors also have the flexibility to alter the premium amounts during the policy's

tenure. For example an individual with access to surplus funds can enhance the contribution

thereby ensuring that his surplus funds are gainfully invested; conversely an individual faced

with a liquidity crunch has the option of paying a lower amount (the difference being adjusted in

the accumulated value of his ULIP). The freedom to modify premium payments at one's

convenience clearly gives ULIP investors an edge over their mutual fund counterparts.


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2. Expenses

In mutual fund investments, expenses charged for various activities like fund management,

sales and marketing, administration among others are subject to pre-determined upper limits as

prescribed by the Securities and Exchange Board of India.

For example equity-oriented funds can charge their investors a maximum of 2.5% per annum on

a recurring basis for all their expenses; any expense above the prescribed limit is borne by the

fund house and not the investors.

Similarly funds also charge their investors entry and exit loads (in most cases, either is

applicable). Entry loads are charged at the timing of making an investment while the exit load is

charged at the time of sale.

Insurance companies have a free hand in levying expenses on their ULIP products with

no upper limits being prescribed by the regulator, i.e. the Insurance Regulatory and Development

Authority. This explains the complex and at times 'unwieldy' expense structures on ULIP

offerings. The only restraint placed is that insurers are required to notify the regulator of all the

expenses that will be charged on their ULIP offerings.

Expenses can have far-reaching consequences on investors since higher expenses

translate into lower amounts being invested and a smaller corpus being accumulated. ULIP-

related expenses have been dealt with in detail in the article "Understanding ULIP expenses".

3. Portfolio disclosure

Mutual fund houses are required to statutorily declare their portfolios on a quarterly basis,

albeit most fund houses do so on a monthly basis. Investors get the opportunity to see where their

monies are being invested and how they have been managed by studying the portfolio.

There is lack of consensus on whether ULIPs are required to disclose their portfolios.

During our interactions with leading insurers we came across divergent views on this issue.

While one school of thought believes that disclosing portfolios on a quarterly basis is mandatory,

the other believes that there is no legal obligation to do so and that insurers are required to

disclose their portfolios only on demand.

Some insurance companies do declare their portfolios on a monthly/quarterly basis.

However the lack of transparency in ULIP investments could be a cause for concern considering

that the amount invested in insurance policies is essentially meant to provide for contingencies


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and for long-term needs like retirement; regular portfolio disclosures on the other hand can

enable investors to make timely investment decisions.

4. Flexibility in altering the asset allocation

As was stated earlier, offerings in both the mutual funds segment and ULIPs segment are

largely comparable. For example plans that invest their entire corpus in equities (diversified

equity funds), a 60:40 allotment in equity and debt instruments (balanced funds) and those

investing only in debt instruments (debt funds) can be found in both ULIPs and mutual funds.

If a mutual fund investor in a diversified equity fund wishes to shift his corpus into a debt from

the same fund house, he could have to bear an exit load and/or entry load.

On the other hand most insurance companies permit their ULIP inventors to shift

investments across various plans/asset classes either at a nominal or no cost (usually, a couple of

switches are allowed free of charge every year and a cost has to be borne for additional

switches).

Effectively the ULIP investor is given the option to invest across asset classes as per his

convenience in a cost-effective manner.

This can prove to be very useful for investors, for example in a bull market when the ULIP

investor's equity component has appreciated, he can book profits by simply transferring the

requisite amount to a debt-oriented plan.

5. Tax benefits

ULIP investments qualify for deductions under Section 80C of the Income Tax Act. This

holds well, irrespective of the nature of the plan chosen by the investor. On the other hand in the

mutual funds domain, only investments in tax-saving funds (also referred to as equity-linked

savings schemes) are eligible for Section 80C benefits.

Maturity proceeds from ULIPs are tax free. In case of equity-oriented funds (for example

diversified equity funds, balanced funds), if the investments are held for a period over 12

months, the gains are tax free; conversely investments sold within a 12-month period attract

short-term capital gains tax @ 10%. Similarly, debt-oriented funds attract a long-term capital

gains tax @ 10%, while a short-term capital gain is taxed at the investor's marginal tax rate.


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Despite the seemingly similar structures evidently both mutual funds and ULIPs have their

unique set of advantages to offer. As always, it is vital for investors to be aware of the nuances in

both offerings and make informed decisions.

Investing in ULIPs?

The high returns (above 20 per cent) are definitely not sustainable over a long term, as they

have been generated during the biggest Bull Run in recent stock market history.

The free hand given to ULIPs might prove risky if the timing of exit happens to coincide with a

bearish market phase, because of the inherently high equity component of these schemes.

While a debt-oriented ULIP scheme might be superior to a debt option in a conventional mutual

fund due to tax concessions that insurance companies enjoy, such tax incentives may not last.

Look beyond NAVs

The appreciation in the net asset value (NAV) of ULIPs barely indicates the actual returns

earned on your investment. The various charges on your policy are deducted either directly from

premiums before investing in units or collected on a monthly basis by knocking off units.

Either way, the charges do not affect the NAV; but the number of units in your account

suffers. You might have access to daily NAVs but your real returns may be substantially lower.

A rough calculation shows that if our investments earn a 12 per cent annualized return over a

20-year period in a growth fund, when measured by the change in NAV, the real pre- tax returns

might be only 9 per cent. The shorter the term, the lower the real returns.

How charges dent returns

An initial allocation charge is deducted from our premiums for selling, marketing and broker

commissions. These charges could be as high as 65 per cent of the first year premiums. Premium

allocation charges are usually very high (5-65 per cent) in the first couple of years, but taper off

later. The high initial charges mainly go towards funding agent commissions, which could be as

high as 40 per cent of the initial premium as per IRDA (Insurance Regulatory and Development

Authority) regulations.


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The charges are higher for a linked plan than a non-linked plan, as the former require lot more

servicing than the latter, such as regular disclosure of investments, switches, re-direction of

premiums, withdrawals, and so on. Insurance companies have the discretion to structure their

expenses structure whereas a mutual fund does not have that luxury. The expense ratios in their

case cannot exceed 2.5 per cent for an equity plan and 2.25 per cent for a debt plan respectively.

The lack of regulation on the expense front works to the detriment of investors in ULIPs.

The front-loading of charges does have an impact on overall returns as we lose out on the

compounding benefit. Insurance companies explain that charges get evened out over a long term.

Thus we are forced to stay with the plan for a longer tenure to even out the effect of initial

charges as the shorter the tenure, the lower our real returns.

If we want to withdraw from the plan, you lose out, as you will have to pay withdrawal charges

up to a certain number of years.

In effect, when we lock in our money in a ULIP, despite the promise of flexibility and

liquidity, we are stuck with one fund management style. This is all the more reason to look for an

established track record before committing our hard-earned money.

Evaluate alternative options

As an investor we have to evaluate alternative options that give superior returns before

considering ULIPs.

Insurance companies argue that comparing ULIPs with mutual funds is like comparing

oranges with apples, as the objectives are different for both the products.

Most ULIPs give us the choice of a minimum investment cover so that we can direct

maximum premiums towards investments.

Thus, both ULIPs and mutual funds target the same customers.

If risk cover is your primary objective, pure insurance plans are less expensive.

When we choose a mutual fund, we look for an established track record of three to five years of

consistent returns across various market cycles to judge a fund's performance.

It is early days for insurance companies on this score; investing substantially in linked plans

might not be advisable at this juncture.


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Try top-ups

Insurance companies allow us to make lump-sum investments in excess of the regular

premiums. These top-ups are charged at a much lower rateusually one to two per cent. The

expenses incurred on a top-up including agent commissions are much lower than regular

premiums.

Some companies also give a credit on top-ups. For instance, if you pay in Rs 100 as a top

up, the actual allocation to units will be Rs 101. If you keep the regular premiums to the

minimum and increase your top ups, you can save up on charges, enhancing returns in the long

run.

Reduce life cover

The price of the life cover attached to a ULIP is higher than a normal term plan. Risk

charges are charged on a daily or monthly basis depending on the daily amount at risk. Rates are

not locked and are charged on a one-year renewal basis.

Our life cover charges would depend on the accumulation in your investment account. As

accumulation increases, the amount at risk for the insurance company decreases. However, with

increasing age, the cost per Rs 1,000 sum assured increases, effectively increasing your overall

insurance costs. A lower life cover could yield better returns.

Stay away from riders

Any riders, such as accident rider or critical illness rider, are also charged on a one-year

renewal basis. Opting for these riders with a plain insurance cover could provide better value for

money.

ULIP's as an investment is a very good vehicle for wealth creation ,but way Unit Linked

Insurance schemes are sold by insurance company representative's and insurance advisors is not

correct.

ULIP's usually have following charges built into it :

a) Up-front Charges

b) Mortality Charges (Charges for providing the risk cover for life)

c) Administrative Charges


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d) Fund Management Charges

Mutual Fund's have the following charges :

a) Up-front charges (Marketing, Advertising, distributors fee etc.)

b) Fund Management Charges (expenses for managing your fund)

A few aspects of investing in ULIPs versus mutual funds.

Liquidity

ULIPs score low on liquidity. According to guidelines of the Insurance Regulatory and

Development Authority (IRDA), ULIPs have a minimum term of five years and a minimum

looking of three years. You can make partial withdrawals after three years. The surrender value

of a ULIP is low in the initial years, since the insurer deducts a large part of your premium as

marketing and distribution costs. ULIPs are essentially long-term products that make sense only

if your time horizon is 10 to 20 years.

Mutual fund investments, on the other hand, can be redeemed at any time, barring ELSS

(equity-linked savings schemes). Exit loads, if applicable, are generally for six months to a year

in equity funds. So mutual funds score substantially higher on liquidity.

Tax efficiency

ULIPs are often pitched as tax-efficient, because your investment is eligible for exemption

under Section 80C of the Income Tax Act (subject to a limit of Rs 1 lakh). But investments in

ELSS schemes of mutual funds are also eligible for exemption under the same section .Besides

the premium, the maturity amount in ULIPs is also tax-free, irrespective of whether the

investment was in a balanced or debt plan. So they do have an edge on mutual funds, as debt

funds are taxed at 10% without indexation benefits, and 20% with indexation benefits. The point,

though, is that if you invest in a debt plan through a ULIP, despite its tax-efficiency your post-

tax returns will be low, because of high front-end costs. Debt mutual funds dont charge such

costs.


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Expenses

Insurance agents get high commissions for ULIPs, and they get them in the initial years,

not staggered over the term. So the insurer recovers most charges from you in the initial years, as

it risks a loss if the policy lapses. Typically, insurers levy enormous selling charges, averaging

more than 20% of the first years premium, and dropping to 10% and 7.5% in subsequent years.

(And this is after investors balked when charges were as high as 65 %) Compare this with mutual

funds fees of 2.25% on entry, uniform for all schemes. Different ULIPs have varying charges,

often not made clear to investors.

For instance, an agent who sells you a ULIP may get 25% of your first years premium,

10% in the second year, 7.5% in the third and fourth year and 5% thereafter. If your annual

premium is Rs 10,000 and the agents commission in the first year is 25%, it means only Rs

7,500 of your money is invested in the first year. So even if the NAV of the fund rises, say 20%,

that year, your portfolio would be worth only Rs 9,000much lower than the Rs 10,000 you

paid. On the other hand, if you invest Rs 10,000 in an equity scheme with a 2.25% entry load, Rs

225 is deducted, and the rest is invested. If the schemes NAV rises 20%, your portfolio is worth

Rs 11,730. This shows how ULIPs work out expensive for investors. Deduct the cost of a term

policy from the mutual fund returns, and youre still left with a sizeable difference.

Comparision Between MF and ULIPS

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