A lot of ink has been spilled over how expenses on ULIPs (unit linked insurance plans) pan out over a period of time. Also, more often than not, the expense structure has not been clearly understood by most individuals who have taken a fancy to ULIPs. This article takes a closer look at the break-up of ULIP expenses and how they affect ULIP returns over a period of time.
Simply put, ULIPs work very similar to a mutual fund with a life cover thrown in. They have a mandate to invest the premiums in varying proportions in gsecs (government securities), bonds, the money markets (call money) and equities. The primary difference between conventional savings-based insurance plans like endowment and ULIPs is the investment mandate- while ULIPs can invest upto 100% of the premium in equities, the percentage is much lower (usually not more than 15%) in case of conventional insurance plans. ULIPs are also available in multiple options like ‘aggressive’ ULIPs (which can invest upto 100% in equities), ‘balanced’ ULIPs (which invest 40-60% in equities) and ‘debt’ ULIPs (which invest only in debt and money market instruments). -
The exact expense structure/ break-up for ULIPs is as transparent as one would have liked. While the expenses are displayed on companies’ websites and in sales literature, the onus of dissecting the available information rests on individuals.
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Broadly speaking, ULIP expenses are classified into three major categories:
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1) Mortality charges
- Mortality expenses are charged by life insurance companies for providing a life cover to the individual. The expenses vary with the age, sum assured and sum-at-risk for the individual. There is a direct relation between the mortality expenses and the abovementioned factors. In a ULIP, the sum-at-risk is an important reference point for the insurance company. Put simply, the sum-at-risk is the difference between the sum assured and the investment value the individual’s corpus as on a specified date.
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2) Sales and administration expenses
- Insurance companies incur these expenses for operational purposes on a regular basis. The expenses are recovered from the premiums that individuals pay towards their insurance policies. Agent commissions, sales and marketing expenses and the overhead costs incurred to run the insurance business on a day-to-day basis are examples of such expenses.
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3) Fund management charges (FMC)
- These charges are levied by the insurance company to meet the expenses incurred on managing the ULIP investments. A portion of ULIP premiums are invested in equities, bonds, gsecs and money market instruments. Managing these investments incurs a fund management charge, similar to what mutual funds incur on their investments. FMCs differ across investment options like aggressive, balanced and debt ULIPs; usually a higher equity option translates into higher FMC.
Apart from the three expense categories mentioned above, individuals may also have to incur certain expenses, which are primarily ‘optional’ in nature- the expenses will be incurred if certain choices that are made available to individuals are exercised.
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a) Switching charges
- Individuals are allowed to switch their ULIP options. For example, an individual can switch his fund money from 100% equities to a balanced portfolio, which has say, 60% equities and 40% debt. However, the company may charge him a fee for ‘switching’. While most life insurance companies allow a certain number of free switches annually, a switch made over and above this number is charged.
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b) Top-up charges
- ULIPs allow individuals to invest a top-up amount. Top-up amount is paid in addition to the premium amount for a particular year. Insurance companies deduct a certain percentage from the top-up amount as charges. These charges are usually lower than the regular charges that are deducted from the annual premium.
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c) Cancellation charges
- Life insurance companies levy cancellation charges if individuals decide to surrender their policies (usually) before three years. These charges are levied as a percentage of the fund value on a particular date.
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