ULIP v/s MF

Uttam B. Sapate
Professor and Head of Management Department Indira College of Engineering & Management, Parandwadi, Pune
uttambsapate@indiraicem.ac.in

Unit Linked Insurance Policy (ULIP) and Mutual Fund (MF) are some of the avenues for investments. Mr. Lal invested in ULIP in June 2005 with annual premium of Rs. 30,000/- with policy term of 15 years. After deduction of policy loading charges, insurance charges (to provide basic life cover of Rs. 227,000/-) and administrative charges, the remaining amount is invested on regular basis in the stock markets in India. The net asset value (NAV) is calculated for the portfolio and the present ULIP value as on 30th April 2011 is Rs. 187,500/- against investment of Rs. 180,000/- even though majority investment is in equity than debt market. Not being happy with overall performance of the ULIP Mr. Lal invested in MFs with Systematic Investment Plan (SIP) option in three diversified MFs from November 2010 with monthly investment of Rs. 6,000/-. As on 30th April 2011 after six months with investment of Rs. 35,000/- the present value of his funds is Rs. 35,261/-. The majority investment has been in the equity MF and only 1/8th amount is invested in debt MFs. Mr. Lal is in highest tax slab and do have home loan principal amount of about Rs. 50,000/- for deduction under 80C. He is in dilemma over his investments in ULIP & MF. Questions: Q1: Compare and explain the Unit Linked Insurance Policy (ULIP) and Mutual Fund (MF) investments. Q2) Analyze the case with assumptions stated clearly considering the stock market behavior for the given period with risk free interest being offered on Public Provident Fund (PPF) of 8%. Q3) Provide suggestions to common investors based on the features of these two investment avenues.

ULIP v/s MF - Case Solution

Q1: Compare and explain the Unit Linked Insurance Policy (ULIP) and Mutual Fund (MF) investments. Answer 1: 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 which are explained on certain common parameters; 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. With present guidelines MFs do not charge any entry load but exit load is charged for withdrawals within one year only. 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. 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. 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. 4. Flexibility in altering the asset allocation The 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. 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 @ 15%. 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. ULIPs v/s Mutual Funds ULIPs Investment amounts Determined by the investor and can be modified as well No upper limits, expenses determined by the insurance company Not mandatory Mutual Funds Minimum investment amounts are determined by the fund house Upper limits for expenses chargeable to investors have been set by the regulator

Expenses

Portfolio disclosure

Quarterly disclosures are mandatory

Modifying asset Generally permitted for free or at a Exit loads within period of one year have allocation nominal cost to be borne by the investor Tax benefits Section 80C benefits are available on all ULIP investments Section 80C benefits are available only on investments in tax-saving funds

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. Q2) Analyze the case with assumptions stated clearly considering the stock market behavior for the given period with risk free interest being offered on Public Provident Fund (PPF) of 8%. Answer 2) In the case under study information about investments by Mr. Lal in ULIP and MF is given. The age of Mr. Lal is not indicated however it is assumed to between 35 to 40 years. The need of Insurance is not spelt out. The basic life cover provided by ULIP is of Rs. 227000/- only. The tax saving under 80C is given importance in both the investments. However, it is expected that the investments offer more returns than risk free interest of 8% being offered on PPF. The comparison of investments and returns for various options are illustrated below; 1. Result of investment in ULIP The ULIP investments attract heavy policy loading charges. The balance amount is considered to be invested giving 8% return. The net value of Rs. 188707.5 matches the present value of ULIP.
Year Investment Deductions Net Investment Compounding period Compound factor @8% Net compounded Value 1 30000 20000 10000 6 1.587 15870 2 30000 2500 27500 5 1.469 40397.5 3 30000 2500 27500 4 1.36 37400 4 30000 2500 27500 3 1.26 34650 5 30000 2500 27500 2 1.116 30690 6 30000 2500 27500 1 1.08 29700 Total 180000 32500 147500

188707.5

2. Result of investment in PPF with separate term insurance plan The regular investment in PPF with 8% returns along with term insurance plan at a cost of Rs. 2000/- per annum would give net fund value of Rs. 220416/-.
Year Investment Deductions for term plan Net Investment Compounding period Compound factor @8% Net compounded Value 1 30000 2000 28000 6 1.587 44436 2 30000 2000 28000 5 1.469 41132 3 30000 2000 28000 4 1.36 38080 4 30000 2000 28000 3 1.26 35280 5 30000 2000 28000 2 1.116 31248 6 30000 2000 28000 1 1.08 30240 Total 180000 12000 168000

220416

3. Result of stock market index based investment with costs of ULIP The regular investment in stock market index based securities along with costs of ULIP would have given net fund value of Rs. 216615/-.
Year Investment Deductions Net Investment Compounding period BSE SENSEX NSE NIFTY Compounding based on SENSEX Compounding based on NIFTY Average compounding factor Net compounded Value 1 30000 20000 10000 6 6679.2 2211.9 2.86500 2.59934 2.73217 27321.7 2 30000 2500 27500 5 10071.4 2962.25 1.90002 1.94092 1.92047 52813.0 3 30000 2500 27500 4 14570.7 4297.05 1.31331 1.33801 1.32566 36455.7 4 30000 2500 27500 3 16063.1 4739.6 1.19129 1.21307 1.20218 33060.0 5 30000 2500 27500 2 14840.6 4529.9 1.28943 1.26923 1.27933 35181.6 6 30000 2500 27500 1 16572.0 4970.2 1.15471 1.15679 1.15575 31783.2 216615 Total 180000 32500 147500 19135.9 5749.5

4. Result of stock market index based investment for MF for six months The regular investment in stock market index based securities along with MF costs at 2.5% would have given net fund value of Rs. 34651.8 for investment of Rs. 36,000/-. The MF investments have beaten the index based stock market investment for a period of six months under consideration and in long term it is expected to give better returns.
Month Investment Deductions @ 2.5% Net Investment Compounding period BSE SENSEX NSE NIFTY Compounding based on SENSEX Compounding based on NIFTY Average compounding factor Net compounded Value 1 6000 150 5850 6 20,355. 6 6117.55 0.94008 0.93983 0.93995 5498.76 2 6000 150 5850 5 19,850.0 5960.9 0.96402 0.96453 0.96428 5641.049 3 6000 150 5850 4 20,561.0 6157.6 0.93069 0.93372 0.93220 5453.411 4 6000 150 5850 3 18,022.2 5417.2 1.06179 1.06134 1.06157 6210.184 5 6000 150 5850 2 18,446.5 5522.3 1.03737 1.04114 1.03925 6079.667 6 6000 150 5850 1 19,420.3 5826.05 0.98535 0.98686 0.98610 5768.728 34651.8 Total 36000 900 35100 19,135.9 5749.5

Q3) Provide suggestions to common investors based on the features of these two investment avenues. Answer 3) Following are some of the suggestions with regard to investment in ULIP & MFs by experts; If you wish to take an aggressive exposure to equity market, go ahead buy any MF. ULIP wont be able to give you similar returns. If you think you are not disciplined enough to make regular investments and need a whip to make you invest, invest in ULIP. If you want to take a low exposure to equity market and still get tax free returns, invest in ULIP but make sure that fund you are invested is conservative fund. If you want Insurance cover and also good return on investment. It is suggested that you invest in MFs and take a term plan. The Systematic Investment Plan (SIP) of Mutual Funds is an appropriate route to regular diversified investments with minimized risk and comparable returns as compared to ULIPs.

References: ULIPs vs Mutual Funds: Who's better? internet article dated. 15th October 2005 on www.rediff.com/money ULIP vs Mutual Fund internet article dated. 3rd January 2008 on blog.moneyraam.com

About Author: Uttam B. Sapate Professor and Head of Management Department at Indira College of Engineering & Management, Parandwadi, Pune. He has 19 years of industrial and 4 years of teaching experience and presently pursuing his PhD in Management from Aligarh Muslim University, Aligarh. E-mail: uttambsapate@indiraicem.ac.in Mob: 9021238042