ULIPs Are Cheaper Than Mutual Funds

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. Broadly speaking, ULIP expenses are classified into three major categories: 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. 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. 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. 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. 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. 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.

Add More Zip To ULIP

The past couple of years have seen ULIPs (unit linked insurance plans) emerge as overwhelming favourites with individuals wanting to buy life cover complemented by a flavour of equities. The Indian bourses too have played a part in fuelling the demand for ULIPs. However, there is one important aspect, which we feel individuals should consider before they commit their money to ULIPs from any life insurance company. Simply put, ULIPs are life insurance plans, which can invest a portion of their corpus in equities. The percentage of investments in equities though differs across insurance companies. While some companies have a mandate to invest upto 100% of their corpus in the ‘aggressive’ option, other insurance companies have a cap (like 35% of corpus for instance) on the ‘aggressive’ option. Given the edge equities can provide to your portfolio, the percentage of equities in a ULIP can make a significant impact on the returns over the long term. An illustration will help in understanding this better. Let us take an example of an individual wanting to invest a sum of Rs 100 (as premium) each year in ULIPs. His investment tenure is 30 years. He has two options to consider- one which offers him a maximum of 35% exposure to equities and the remaining 65% in debt instruments. The other option offers him 100% exposure to equities. Let us also assume that he is expecting a 10% growth year-on-year CAGR (compounded annual growth rate) from the equity component and a 7% growth CAGR from the debt component. The individual is assumed to have a high-risk appetite and hence, he decides to invest his entire corpus in the aggressive option throughout the tenure. THE POWER OF EQUITIES ------------------------------------Ulip from comp A------------Ulip from comp B Amount invested(Rs)----------------------------100--------------------------100 Equity exposure (%)------------------------------35--------------------------100 Amt receivable on maturity from equity (Rs)-------------------------------6,333 -----------------------18,094 Debt exposure per annum (%)-------------------65---------------------------0 Amt receivable on maturity from debt (Rs)-----6,570 ----------------------- 0 Total amt. receivable on maturity (Rs) -------- 12,903 ------------------- 18,094 CAGR on equities is assumed to be 10% and on debt to be 7%. Tenure is 30 years. As can be seen from the table, if a sum of Rs 35 is invested each year (out of the Rs 100 paid as premium) in equities for a period of 30 years and the rate of returns is assumed to be 10% CAGR, then the individual stands to gain Rs 6,333 on maturity. Also assuming that the remaining Rs 65 is invested in debt instruments for the same period and this yields 7% CAGR, the maturity amount works out to Rs 6,570. The total amount that the individual stands to receive on maturity is Rs 12,903. As opposed to this, if the individual were to invest the entire amount of Rs 100 in equities, other variables remaining the same, the returns amount to Rs 18,094. Which is approximately 40% higher than the returns that the individual would have received had his investments been ‘limited’ to a 35% equity exposure! So what does this mean for an individual who wants to invest in ULIPs? To begin with, several studies have shown that equities tend to outperform other asset classes like bonds and gsecs over the long term. It therefore makes sense for the risk-taking individual to invest a sizable portion of his corpus in equities. Therefore it also follows that a ‘maximum 35%’ equity exposure will not be able to power the individual’s portfolio returns like a 100% equity exposure would, other parameters (tenure, expected returns, premium amount) remaining the same. Add to this the fact that the 100% equity ULIP option also allows the individual to shift his money to debt in varying proportions (which range from 0%-100%), and one has a potent combination. Of course, the return figures will change with a change in the assumptions considered above. For example, had we assumed a 15% return on equity without changing the other parameters, then the difference in returns between the 35% equity option and 100% equity option would be 107%! Conversely, if we compare a 35:65 (equity: debt) portfolio versus a 70:30 (equity: debt) portfolio without changing the other parameters, then the difference in returns would have been approximately 22%. Of course, it goes without saying that many factors other than the equity exposure affect ULIP returns. For example,expenses and the quality of fund management are two very important factors that need to be evaluated before taking the plunge into ULIPs. Individuals therefore need to bear in mind that a ULIP needs to be evaluated on various parameters before zeroing in on a particular life insurance company.

Human Life Value Calculations

Life Insurance has always been a rather neglected area in the mindset of the public. Historically consumers have bought life insurance for reasons of tax saving rather than the core need of providing for one's family in case of death of bread-winner. Secondly, the Indian consumers have been unaware that the insurance need changes with every change in life stage (e.g., if one gets married or has children one's need for insurance goes up). As a result only 8% of India's population is insured and the average insurance size is around Rs. 80,000. This implies that people who think they are insured are also heavily under-insured. One of the most significant reasons for this is the inability of the advisor / agent to educate the customer about the true nature of life insurance. They have tried to highlight the product rather than the need. The need for risk coverage / the need to provide for an untimely death is more difficult to explain and hence has been till lately ignored. Aggravating the situation was the fact that term insurance was expensive until recently. Basically, the amount of insurance one should buy is directly dependent on his/her economic value, otherwise known as the 'Human Life Value'. This varies from person to person. 'Human Life Value' is the capitalized value of the net earning of an individual for the rest of his working span. It is, in short, the present value of the total income of the individual, which his lost to the family in the event of his untimely death. Let us take an example,Mr. X, aged 35, earning a gross income of Rs. 2 lakhs today, will retire at the age of 65. Age of a Person ------------------------------35 Age of Retirement----------------------------65 Years to Retirement --------------------------30 Annual Gross Income------------------------ Rs 2,00,000 Personal Expenses + IT---------------------- Rs 56,000 Net Disposable Income -----------------------Rs 1,44,000 Annual growth in Income (10% every yr)--------- 10% Total Income till Retirement------------------ Rs 2.36 Crores Rate of discounting --------------------------------6% Net Present Value -----------------------------Rs 41.24 Lacs If he doesn't return home today, his family will lost this amount forever. Therefore, Mr. X's Human Life Value = Rs. 41.24 Lakhs. A simpler way of looking at it is as follows: Suppose , Monthly income of a person -----------------------------------Rs.10,000 His personal expenses per month------------------------------ Rs.2,000 Monthly income provided to family ----------------------------Rs.8,000 Therefore, annual income provided ----------------------------Rs.96,000 Amount of money to be put in the bankto earn Rs.96,000 pa at 6% interest rate ---------Rs 16,00,000 Hence, HLV is ------------------------------------------------Rs 16 lakhs Please note that however we have not taken into account the future income growth of the person. This is, therefore, not an exact way of calculating the Human Life Value. This is only a representation to give the customer a fair idea of how this works. Normally, when the Human Life Value concept is used, the amount arrived at is much more than what the prospect would have normally thought of. The Advisor, therefore, must necessarily suggest a package, which covers this amount at an affordable premium. For example, if we calculate the premium amount for Rs. 16 lakhs pure term cover for a 32-year-old man, the amount will be roughly around Rs. 6,000 pa for a term of 20 years. This works out to just 5% of his annual salary (annual salary equal to Rs. 1,20,000). Thus, dying too soon or rather planning for uncertainty of life is the most important need that life insurance fulfils. However, there are other objectives that one could have in mind, which can be achieved through life insurance. The important ones being : Living too Long - Retirement Planning Living Death (physical disability etc) Children's Education and Marriage Wealth and Estate Creation Hence, depending on his objectives, the quantum of life insurance can vary.

ULIP vs Mutual Funds

This is really a hot topic. Now-a-days everybody says why we will invest in ULIPs ( Unit Linked Insurance Products) rather than investing in Mutual Funds? Given below is the solution based on the client’s needs : The insurance component To begin with, we knew from our interaction with the client and based on the Human Life Value Calculations that he is underinsured. An immediate action point for him would be to buy a term plan. And considering his annual income, he would need to buy a term plan for more than the sum assured recommended on the ULIP (i.e. Rs 5,000,000). Even if we were to consider his sum assured to be Rs 5,000,000 (as per the ULIP) for a term plan, the annual premium he would have to shell out would be approximately Rs 30,000 per annum for a 30-Yr period. The investment component Having taken care of the client’s insurance needs, now let’s shift our focus to his investments. We took into consideration the client’s current financial portfolio. He had a sizable portion of his portfolio invested in fixed income instruments like bonds and fixed deposits. Bearing this in mind, our view was he did not need to have another debt-heavy (ULIP with a 65% debt component) product in his portfolio. Instead what his portfolio needed was a higher equity component; this would not only ‘balance’ his portfolio but also ensure that the portfolio reflects his true risk profile. It was also relevant that the client invest in equities since he was considering his investments from a long-term (over 30 years) horizon. This could be achieved by investing in equity-oriented mutual funds. Mutual funds can offer several benefits: Several studies have shown that over the long term, equities give a higher return vis-à-vis fixed income instruments like bonds and gsecs. And given that the client’s investment horizon is of over 30 years, this is an ideal time frame to reap the rewards of investing in equities. Also, over a 30-Yr period, a 100% equity mutual fund is better geared to outperform a ULIP portfolio with a 65% debt component.(Click here to understand how a potfolio dominated by equity can outperform a debt-heavy portfolio) ULIP tend to be expensive propositions (vis-a-vis mutual funds) during the intial years. However, over longer time horizons, the expenses balance out and ULIPs work out to be cheaper as compared to mutual funds. However, even if the lower expenses of a ULIP vis-à-vis that of a mutual fund scheme were to be considered, the latter would still surface as the better option. Several mutual funds have a proven track record extending over several years and across market cycles. ULIPs do not have much of a track record to show for; in fact most ULIPs are yet to experience a bear phase. Investing in a mutual fund portfolio will offer the benefit of diversification to the client. The investor will reap the reward of diversifying across several fund management styles. On the other hand, by investing all his money in just one ULIP, the client would be committing his entire corpus to just one style of investment. This can prove to be quite risky over the long term. You can make adjustments to your mutual fund portfolio. If you believe you have made a wrong investment decision, you can redeem your investment in a particular mutual fund and invest in another one. Such adjustments are not entirely feasible in a ULIP. The tax aspect We also had to contend with Section 80C tax benefits. However, given the client’s annual income, the Section 80C tax benefits were being taken care of by way of Employees’ Provident Fund (EPF) as well the recommended term plan. The client therefore can invest in regular diversified mutual funds and not necessarily in tax saving funds (ELSS). As can be seen, term plans combined with mutual funds have the potential to add considerable value to an investor’s portfolio. In our view individuals should first ensure that they are adequately covered by opting for a term plan. Then they can either opt for ULIPs for the investment component or as we have shown, they can consider mutual funds.

Important Questions That Arises

Do I need life insurance? Your income can be considered your family's most valued asset because it allows you all to obtain the necessities of life and, of course, all the creature comforts. But some day you may not be there to provide the income — yet your dependents would need the income. This is where a life insurance proves useful for them. The amount required will depend on your personal and financial circumstances. If any of the following statements applies to you, you probably need to consider life insurance: 1. You have a spouse 2. You have dependent children 3. You have an ageing parent or disabled relative who looks upon you for support 4. Your retirement pension / savings are not enough to ensure your spouses future against a rising cost of living. 5. You own a business In addition to the comfort of knowing that you have provided for your family in case of an eventuality, there are several other reasons Deferred tax benefits on the insurance policies Access to funds available through whole life policies, etc, where you can borrow money for big ticket expenses. You can gift it or use it to divide your estate ie pass it to a beneficiary in your will. How much is enough? A good financial advisor can help you with a "need analysis" through which you can estimate your permanent and temporary liabilities, look at the availability of emergency funds at your disposal, your liquid assets and then estimate the insurance cover you require. A good life insurance policy can even help you overcome financial problems and further provide the assurance that your dependants are taken care of after you. It is only natural that you should wonder what should be the appropriate value of the insurance you need. Also remember that your insurance needs change through different stages of your life. When you are young, there is a lower need for life insurance. However, as you grow older and your responsibilities to your family increase, so do your life insurance needs. Therefore, you will need to review your coverage requirements approximately between four and seven times in a lifetime. Basically, the amount of insurance one should buy is directly dependent on what is best described as your economic value, otherwise known as the 'human life value'. This varies from person to person. The human life value is the capitalised value of the net earning of the individual for the rest of his working life. It is, in short, the present value of the total income of the individual, which is lost to the family in the event of his untimely death. Earnings of an individual till retirement For Example X, aged 25, earns a gross income of Rs3-lakh per annum and would retire at the age of 60. In case of his passing away at the present age his family would stand to lose his future income, which amounts to Rs1.05 crore (the remaining 35 years x Rs3 lakh per year). This lost income of Rs1.05 crore is the "human life value" of X. The amount of life insurance you would require is evident from this exercise. Which type of life insurance policy? There are several types of insurance and there are many decisions you will have to make when assessing your life insurance needs. The first of which, is whether you need whole life or a term insurance / universal plan. A simple way to understand the differences between these two types of life insurance is by comparing them to something familiar to all of us. To take a very simple example, think of buying a whole life insurance product as owning a home and buying term insurance as renting one. There are advantages and disadvantages to both. Like owning property — owning whole life is usually an appropriate way for people to meet their long term needs. Over time it may be the least expensive form of life insurance since payments may be fixed and it builds equity. Plus this equity (called the cash value) accumulates on a tax deferred basis. In contrast, purchasing term insurance, like renting property, is usually an appropriate way of meeting short-term or temporary needs. Taking the analogy further the differences are highlighted as - living in owned premises versus living in rented premises:

Types of Insurance

All policies are not the same. Some give coverage for your lifetime and others cover you for a specific number of years. Here is a snapshot of the types of policies and what they offer. Term Insurance Term insurance covers you for a term of one or more years. It pays a death benefit only if the policy holder dies during the period the insurance is in force. Term insurance generally offers the cheapest form of life insurance. You can renew most term insurance policies for one or more terms even if your health condition has changed. However, each time you renew the policy for a new term, premiums may climb higher, just like a rent agreement every time you renew the lease. This policy is particularly useful to cover any outstanding debt in the form of a mortgage, home loan, etc. For example if you have taken a loan of Rs10 lakh, you will have an option of taking an insurance to protect the loan in case of passing away before the debt is repaid. Whole Life Insurance Whole life insurance covers you for as long as you live if your premiums are paid. You generally pay the same premium amount throughout your lifetime. Some whole life policies let you pay premiums for a shorter period such as 15, 20 or 25 years. Premiums for these policies are higher since the premium payments are made during a shorter period. There are options in the market to have a return of premium option in a whole life policy. That means after a certain age of paying premiums, the life insurance company will pay back the premium to the life assured but the coverage will continue. Money Back Insurance The money back plan not only covers your life, it also assures you the return of a certain per cent of the sum assured as cash payment at regular intervals. It is a savings plan with the added advantage of life cover and regular cash inflow. This plan is ideal for planning special moments like a wedding, your child's education or purchase of an asset, etc. Money back plan have "participating" and "non participating" versions in the market. Endowment Assurance Endowment insurance is a level premium plan with a savings feature. At maturity, a lump sum is paid out equal to the sum assured (plus dividends in a par policy). If death occurs during the term of the policy then the total amount of insurance and any dividends (par policy) are paid out. There are a number of products in the market that offer flexibility in choosing the term of the policy namely you can choose the term from five to 30 years. There are products in the market that offer non participating (no profits) version, the premiums for which are cheaper. Universal Life This is a flexible life insurance policy and is also market sensitive. You decide on the several investment options on how your net premium are to be invested. While the mony invested has the potential for significant growth, such funds are subject to market risks including the loss of the principal. Unit Linked Insurance Product (ULIP) Market-linked plans or unit-linked insurance plans (ULIP) are similar to traditional insurance policies with the exception that your premium amount is invested by the insurance company in the stock market. Market-linked insurance plans (MLP) mimic mutual funds and invest in a basket of securities, allowing you to choose between investment options predominantly in equity, debt or a mix of both (called balanced option). The major advantage market-linked plans offer is that they leave the asset allocation decision in the hands of investors themselves. You are in control of how you want to distribute your money among the broad class of instruments and when you want to do it or pull out. Any of the products mentioned above except term products could be unit-linked. Riders Riders are additional add-on benefits that you could opt to include in your policy over and above what the policy may provide. However, these additions come at an extra premium charge depending of the rider you opt for. These riders cannot be bought separately and independently. The extra premium, nature and characteristics of the riders are based on the base policy that is offerred. Some riders available in the market are : 1. Accident Death Benefit: Provides a additional amount in case death occurs as a result of an accident. 2. Term Rider: It allows the payment of an additional amount should death of the insured happens. 3. Waiver of Premium: In case of total and permanent disability of life insured due to accident or any other means this rider allows premiums on base policy or riders to be waived. 4. Critical Illness: It provides payment of an additional amount on the diagnosis of some critical illness.

Insurance

Hi, let us get into some serious talk now. You will wonder why I have included this insurance part in this blog. It is not because I care for you all but it is because i want to create an awareness in you all about insurance. Life insurance plays an important role in any individual's financial planning process. For it is life insurance that helps secure the financial future of the nominees. However, many individuals do not know how to go about while considering life insurance products. I have identified five points to remember before zeroing in on a life insurance product. Identify your needs Before considering life insurance, it becomes imperative that individuals first identify their needs. An individual should understand whether buying life insurance is necessary to begin with. For example, if an individual is single and earning but has no financial dependants, then he may not really need life insurance. This stems from the fact that nobody is going to be 'financially hurt' in the absence of the insured (i.e. the individual in question). On the other hand, we can consider a married individual who has family members dependent on him. He also happens to be the sole earning member in the family. Such an individual obviously needs life insurance. This stems from the fact that his entire family is dependant on him for financial support and in his absence, their lifestyle would be severely impaired. Such individuals should have adequate life cover as early as possible. How much insurance do you need? After having identified the need to buy insurance, the next step is to ascertain the amount of cover needed. The concept of human life value (HLV) can help in deciding how much life cover an individual should opt for. The HLV takes factors like the individual's annual income and expenses along with the inflation rate into consideration while calculating the value. Which product should you consider? After having quantified the need for insurance, the next step is to finalise a plan that will fulfil the individual's need. There are two kinds of insurance plans - term plans and savings-based plans. A term plan insures the individual for a high sum at a low cost. A term plan makes for a good fit in all individuals' portfolios, irrespective of their profile. Many individuals also look at life insurance as a savings instrument. Here, apart from insuring the individual's life for a certain amount (i.e. the 'sum assured' in insurance parlance) savings-based life insurance plans also give returns on maturity. This is unlike term plans, which act as a pure risk cover and do not give any returns on maturity. Select an insurance agent Having understood how much insurance is needed, an individual then needs to approach a life insurance agent. Individuals wanting to buy insurance should preferably opt for full-time life insurance agents. The agent should have a good track record to show for in terms of offering objective advice in the client's favour and not his own. This will stand the individual in good stead over the long run since life insurance needs call for evaluation every few years and the insurance agent will help the individual with the same over a period of time. Compare policies across companies Before zeroing in on an insurance plan from any company, individuals should compare policies across insurance companies. This will help them in evaluating which insurance plan is best suited to their needs. One way of doing this is by contacting the insurance agent and asking him for a comparative analysis of insurance plans. Another way is by visiting the websites of different companies and scouting for relevant information. For example, an ideal term plan for a 25 year old can be the one that offers him the necessary cover at the cheapest cost. For a unit linked insurance plan however, different criteria like expenses, fund management and flexibility offered will come into the picture. The comparison will differ across various parameters depending on individual needs as well as the type of plan chosen.

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