Ulips are better, but still not good enough
4 min read 05 Jul 2016, 05:38 PM ISTUlips are much better than they were in 2009 but to be market-ready they need more work
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Is a unit-linked insurance plan (Ulip) a good product? The question is asked quite often on my Twitter timeline. Life insurance industry chief executive officers talk about this all the time. And there is some media chatter on the coming of age of Ulips. What’s the truth and how should you think about it? Let us apply the principles first. A financial product is bought because it solves a financial problem you have. It should perform on metrics of cost, benefits, tax efficiency and ease of transaction. It should compare well with other products that solve the same problem.
Let us examine a Ulip on some of these metrics. First, what problem does a Ulip solve? As a hybrid product it offers a life insurance cover and a market-linked investment product. What other products solve the same problem? A pure term policy (life insurance only, no money back unless you die) gives life cover. The investment part has many competing products, but the closest in terms of structure is a mutual fund where a daily net asset value (NAV) allows you to see the real-time value of the portfolio. Let us open up the NAV a bit more. There is some confusion in the minds of investors as to what NAV means. In the case of a mutual fund, an NAV is the value of each unit after all the costs have been accounted for (minus the taxes and various cess). Therefore, when investors calculate return on the basis of the NAV difference, they get their actual return. For example, if you buy at an NAV of 55 and sell at 100, your profit will be 45. If 1 lakh is invested, at 55 you will get 1,818 units (ignoring decimals). At an NAV of 100, your fund value becomes 1.81 lakh. The number of units remains the same.
What about a Ulip? The NAV of a Ulip is the value of each unit minus the cost of just fund management. Other costs sit outside the NAV, making it not so ‘net’. Let us continue with the 1 lakh investment example. The entire 1 lakh is not invested into the fund; the commission is deducted before units are bought. At the industry average of 8% of the premium (this was extensively researched and arrived at by the Bose Committee at between 7% and 9% of the premium), a cost of 8,000 gets deducted. Now 92,000 goes to buy units. At an NAV of 55, you get 1,672 units. But there are other costs such as the mortality cost (the cost of the life cover), the policy administration charge and others like the charge for switching. Insurers deduct these by unit cancellation. This means that if the charges were 11,000, at an NAV of 55, the company would cancel 200 units. So instead of 1,672 units, at the end of the year, you will be left with 1,472 units. A simple NAV to NAV comparison leaves out the fact that the number of units has fallen, reducing the return.
How does the cost of the life cover in a Ulip compare with a term plan? Here, again, the problem with bundling emerges. My colleague Deepti Bhaskaran, who has decoded almost every new policy the industry launches, has flagged the issue of Ulips charging up to 50% more for mortality than an online term plan. Read this story for more: https://mintne.ws/1oKJOCs . And for the more ambitious, read this older story that compares the net present value of the Ulip versus term plan costs: https://mintne.ws/1aczMfK .
The higher mortality cost and the sales load reduce your returns but when agents show Ulips as giving 18% returns on a five-year average, they omit to nuance this return to give you the real post-cost return. They forget to tell you that your units are getting reduced due to costs you don’t see.
Ulips got a makeover in 2010 after which the toxic trap like features were removed. It became a better product but is not yet able to compete in the market with a mutual fund plus term plan combo. There are three reasons for that. One has already been flagged above—bundling hides many sharp sales and business practices.
Two, the investment is not ‘portable’ though you can ‘switch’ between funds of the same insurer. Market-linked investments need to be portable so that a bad fund manager can be discarded for a better one. Ulips are like closed-end mutual funds where you are stuck with your fund manager till the end. What about the ability to ‘switch’ between the funds? Many Ulip investors have been sold the mirage that effortless ‘switching’ is the road to good returns. ‘Switching’ between either an equity type of fund (large-cap, mid-cap or sector fund) or between equity and debt is market timing if you are doing it several times a year. You and me as average retail investors can never predict the market. For example, financial planners were flooded with anxious sell orders just before Brexit. The investors who allowed themselves to be counselled did not sell or switch, others did. Two weeks later, those who sold are feeling just a little bit sorry for leaving the planning path. So ‘switching’ and ‘portability’ are different things. You need a low-cost portable product.
Three, there aren’t any industry standard benchmarks against which you can compare your Ulip fund. Remember that a 100% fund return means nothing if the benchmark returned 120%.
Ulips are much better than they were in 2009 but to be market-ready they need more work. You should stay with a term plus mutual fund strategy for your money box.
Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint, consultant NIPFP, member of the Financial Redress Agency Task Force and on the board of FPSB India. She can be reached at monika.h@livemint.com
