Unit Linked Insurance Policies (ULIPs) as an investment avenue are closest to mutual funds in terms of their structure and functioning. As is the case 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.

Despite the seemingly comparable structures there are various factors wherein the two differ.

In this article we evaluate the two avenues on certain common parameters and find out how they measure up.

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.

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 and for long-term needs like retirement; regular portfolio disclosures on the other hand can enable investors to make timely investment decisions.

ULIPs vs Mutual Funds

* There is lack of consensus on whether ULIPs are required to disclose their portfolios. While some insurers claim that disclosing portfolios on a quarterly basis is mandatory, others state that there is no legal obligation to do so.

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 good, 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.

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.

Ever since unit-linked insurance plans (ULIPs) made their debut, they have become a subject of much discussion and debate. On the one hand, they were a trifle too complicated for individuals not yet exposed to the stock markets; on the other hand, they were much-maligned because of the ‘unusually high’ costs.

As ULIPs made their presence felt, insurers were more open to discussing the costs and how they evened out over the long term. This and the flexibility that ULIPs offer became important points that made individuals consider adding them to their portfolios.

Today, more individuals are open to using the ULIP-way to create wealth over the long term. Here we outline exactly how ULIPs can help you fulfill that responsibility.

If you are between 25 and 35 years of age

You are young, probably married and even have kids. If you are the sole breadwinner in the family, then you have quite a few responsibilities to fulfill right from planning for your child’s education/marriage to planning for your own retirement to providing for the family in your absence.

The last responsibility is the most critical and ironically it is the easiest and cheapest one of the lot to fulfill. At Personalfn, we have always been votaries of term insurance — the cheapest way to get a life cover for yourself.

Term insurance is also insurance in its ‘purest’ form, in other words there is no savings element in it, which ensures your premiums are very low. There is no better product to provide for your family in case of an eventuality and all individuals must consider taking a term plan.

Term insurance of course takes a huge burden off your chest as also your wallet. But it still leaves you with a problem. If term insurance is only going to take care of the ‘risk’ element, who is going to take care of the ’savings’ part.

This is where ULIPs come in. Of course, that is not to say that ULIPs do not have an insurance element, they do, but it is limited largely to the earlier years and after a point they don the mantle of an investment product.

So how can ULIPs help you save for child’s education/marriage, planning for retirement and other investment-related objectives? ULIPs can do all this and more because they come with a lot of variety.

Consider this; except for term insurance (because it does not make sense), just about every life insurance product has a ULIP option. So you have endowment ULIP, child plan ULIPs and pension ULIPs. As a matter of fact, there are some life insurance companies that only have ULIP products; they don’t have traditional endowment, pension and child plans at all!

What that tells you is that if you are willing to take on some risk, a ULIP can help you meet a lot of your financial objectives.

If you are looking to set aside some money for your child’s education, the 5%-6% return on an endowment plan may not even take care of inflation, let alone provide for a medical or MBA degree. The return you earn on a child plan should not just counter inflation, it should be enough to cover the cost of education.

And the way cost of education is spiralling, your insurance plan must work very hard. Given their equity component, ULIPs are ideally placed to fulfill this role.

As we mentioned before, ULIPs are flexible; there are various options within a ULIP with the equity component varying right from 0% to 100%. This ensures that you are able to select an option that best suits your risk profile. Let us understand how ULIPs can be tailor-made to serve your financial planning needs.

You are in the 25-35 years age bracket. Your most pressing financial objectives are providing for your child’s future and your own retirement. ULIPs can help you achieve both. Although you can take a single endowment ULIP to achieve both objectives, we think it is more prudent to make a demarcation between the needs and take separate ULIPs dedicated to each objective.

Opt for a ULIP child plan to provide for your child’s higher education, marriage and seed capital for business to name a few needs. One way to handle this multi-faceted objective is to take a ULIP money-back plan. This way you get monies at regular intervals to address multiple needs.

The other important plan that individuals must consider taking earlier on their lives is a pension plan. Building a corpus to face the rigours of retirement should be given the priority it deserves.

Again, a long-term investment objective like retirement planning could do with an equity ‘push’. Here is where a ULIP pension plan can add value to your retirement portfolio. Likewise a ULIP endowment plan can help you meet investment objectives like buying property or setting up a business for instance.  

If you are between 35 and 45 years of age

By the time you reach the 35-45 age bracket, some of your existing ULIPs are probably nearing maturity. For instance, if you had taken a ULIP child plan earlier on, it is likely to mature in this age bracket to coincide with the need (higher education/marriage) you had in mind at the time of taking the ULIP.

However, if you married late or did not begin planning your finances at an early stage in your life, now is the time. If you haven’t insured yourself as yet, go for a term insurance plan.

The advantage of taking a term plan at a slightly advanced age is that you have a better idea of how your lifestyle is likely to pan out going forward. In terms of costs, term plans remain your cheapest option no matter when you take one.

You can opt for some of the ULIPs we mentioned for individuals in the 25-35 years age bracket depending on your needs. Remember, unlike endowment, which gets really expensive at an advanced age, ULIPs because of the way they are structured, do not turn out that expensive.

If you are over 45 years of age

In this age bracket, it is likely that you are insured. However, you still need to review your insurance cover taking into consideration the changes in your lifestyle, income, needs and financial commitments. Beef up your insurance cover through a term plan.

By this time, your ULIP pension plan will have matured. You can then opt for an annuity, immediate or deferred, depending on your requirements.

6 points to note

Since ULIPs offer a lot of flexibility, you need to keep some points in mind to optimise the benefits associated with them.

• Notice we have recommended ULIP child plans/pension plans and even term insurance for most individuals. When you opt for these plans it is important you do this after taking your insurance consultant into confidence. He is the one who is going to help you with the numbers, so you need to tell him exactly what you are looking for in an insurance plan.
• Remember there is an insurance cover associated with ULIPs. Since it is also likely that you have other insurance plans like term and/or endowment, it is important you have a clear idea of exactly how much your insurance cover is worth after considering all your insurance plans. This number will prove helpful when you review your insurance cover at regular intervals.
• Likewise, ULIPs also have an investment element. You are likely to have investments in mutual funds, stocks, bonds and fixed deposits as well. You need to add up the market value of all these investments while calculating your investment worth. This number will prove useful when you wish to beef up your investments in a particular asset.
• ULIPs derive their ‘power to perform’ from equities. When you have a lot of aggressive ULIPs in your portfolio it means that you are overweight on equities. Add to this your investments in stocks and equity funds, and your exposure to equities increases even further. To temper your equity exposure, it is generally advisable to opt for conservative/balanced ULIPs (maximum 50% equity exposure).
• Even if you are a high-risk investor, you must gradually shift your assets to a conservative ULIP option as your age advances. Financial prudence dictates that risk reduces as age increases; this needs to reflect in all your investments including ULIPs.
• Like with all investments, it is prudent to diversify your ULIP investments. This is necessary due to several reasons with financial prudence being the most important reason. Varying flexibility levels in ULIPs across insurance companies is another factor that should make you opt for a ULIP from more than one insurance company. Varying level of expenses in ULIPs is another reason to opt for ULIPs across insurance companies to keep expenses on the lower side.

The market regulator Securities and Exchange Board of India, SEBI, in January 2008 abolished entry load on Indian equity funds if you invest directly. However, it is mandatory to pay an entry load of 2.25 per cent if you transact through intermediaries also called as distributors by you and me. The distributors take this charge to service investors.

How is it levied on the investor?

Investor has to be careful and aware of how this charge is levied since nobody asks you to pay this charge separately. Instead it is deducted upfront from your investible money right at inception.

Suppose you are investing Rs 100 and NAV (the net asset value) of the scheme that you are buying is Rs 10. This NAV is multiplied by 1.0225 (2.25 per cent of Rs 10) to factor in the entry load and operative NAV for you becomes Rs 10.225 (Rs 10 as the actual NAV and Rs 0.225 as the entry load).

This takes the number of units allocated to you therefore to 9.78 and the money invested is Rs 97.8 instead of Rs 100. The remainder Rs 2.2 (100 less 97. goes to the distributor and to meet other administrative expenses incurred by the mutual fund company. However, if you invest directly through that mutual fund company’s website then full Rs 100 is invested and you hold 10 units.

Cascading effect of this cost

While you lose this money upfront, this charge literally multiplies. For example, even on a conservative basis, Indian equities can double in the next 5 years. Since 2.25 per cent has been deducted upfront and not been invested, what you have lost is 4.5 per cent (double of 2.25 per cent) from your returns.

Consequently it is a simple decision that you should invest directly and not pay this significant charge.

New favourable development

Abolition of this load is leading to emergence of fee based wealth management advisories in India. Money, which you save through direct investment — just a fraction of that could be utilised to buy the services of such an advisory.

They will facilitate your direct transactions in addition to host of other wealth management services.

Analysis of charges

On an average we are assuming that you are paying a rate of 0.4 per cent of assets under management (AUM) annual fee to your advisor. Since timing of cash outflows is different, we will have to take time value of money into consideration.

Paying 2.25 per cent of upfront commission is equivalent to paying 0.4 per cent of AUM every year for 13 years. In other words, what you are paying for 13 years, you lose in one single shot when somebody charges you 2.25 per cent upfront.

Additionally, a transaction based company which has tasted blood by getting an upfront commission of 2.25 per cent is likely to turn over your portfolio very soon and many times over even when not required.

On the contrary, a fee based advisor wins only when you win and their interests are totally aligned with yours. Even when he reallocates, it is at zero cost to yours and at no advantage to such an advisor and therefore it will be done only when really required.

Conclusion & recommendation

Consequently my strong recommendation will be to take full advantage of this gift and investor friendly move from SEBI, save lots of money and bolster your returns

(Source: Rediff.com/getahead/ )